“The Dwindling Allure of Building Factories Offshore”

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A recent article in The Economist describes “The dwindling allure of building factories offshore.” The article concludes that “Increasingly, it makes sense to make things in a variety of places, including America.”

I agree. Medical device companies face the same global opportunities and challenges as other manufacturers. While moving medical device manufacturing to a low-wage location sounds like a no-brainer, it takes real skill and experience to make it work well. Sometimes it makes sense, and sometimes it doesn’t.

How do you decide?

Like many high-stakes business decisions, you need to crunch some numbers to help drive a good decision. Consider hiring outside experts who do this for a living. What should you be modeling? Here are some of the factors to consider.

Labor Intensity of your product. Medical capital equipment is usually materials intensive, with labor costs comprising less than 10% of the product cost. Efforts to reduce materials costs are likely to have a larger benefit than locating in a low-wage location. To reduce product costs at Candela, we put our effort into improving supply chain quality and reducing parts costs. On the other hand, single-use products, from catheters to tubing sets, are more likely to benefit from low-wage locations.

Wage rates versus productivity. While wage rates may be lower in Asia or Latin America, output per employee-hour may also be lower. Make sure to investigate this with other factories in the area, as you are considering and modeling the benefits oflow-wage locations.

Engineering expertise required. I can’t imagine moving LVAD manufacturing off-site, much less out-of-country. In an ideal world, product designs are frozen at the time of product release, and manufacturing processes run for years without a hitch. In the real world, development engineers are often called upon to resolve design-related issues that are identified in manufacturing or the field. Even at the best of companies, it’s simply not possible to get everything 100% right at launch. I have seen tolerance stack-up issues that weren’t identified in development, electronic component obsolescence that requires circuit redesign, manufacturing process improvements that involve design changes, and loads of other issues. For products that require significant engineering support, a long distance between manufacturing and design engineering can be extremely costly.

Frequency of new product introduction (NPI) versus volumes produced. NPI is another engineering-intensive activity. NPI costs are amortized over a production lifetime, so frequent NPI’s with smaller lifetime product volumes argue for co-locating engineering and manufacturing.

Supply chain location. Supplier distance to your plant matters. That’s why new parts suppliers spring up around every new Toyota plant in the midwest. Every plant requires an ecosystem of local suppliers, from machined parts to molded parts to printed circuit boards. Supply chain transportation costs can be significant if your supplier is far away. Coordination of supplier and plant activities is important too.

Customer location. At Candela we looked at putting a central re-manufacturing facility in Europe. Customer location was the single biggest factor that drove the location recommendation. As with suppliers, transportation costs are important. Responsiveness is important too. No customer likes to wait days or weeks for product to be shipped from some remote location.

Exchange rate risk. Since country-specific pricing is often fixed in local currency, swings in exchange rates can wreak havoc on gross margins. While your back office can hedge some exchange rate risks, there can be major long term benefits to manufacturing and selling in the same currency.

Taxes. According to IDA Ireland (Industrial Development Agency), “Ireland is home to 15 of the world’s top 20 Medical Technologies companies and a proven location for high value Manufacturing and R&D.” One big reason is Ireland’s highly favorable corporate tax rate. While I’m not usually one to let tax policy drive operational decisions, tax savings can be significant.  Make sure you understand this one.

Regulatory compliance. For medical device companies, there are some borders that are challenging to cross. Import/export regulations and customs practices can impact your ability to bring goods from the country of manufacture to the countries of your market. No one likes to have goods stuck for days or weeks in customs.

Lean opportunities at home. Before you go through the trauma of moving offshore, ask yourself if you can dramatically improve productivity in your current plant. My colleagues know I am a huge proponent of lean manufacturing. My teams made huge improvement in costs, quality and on-time-delivery at Thermo Cardiosystems and Candela. With lean approaches, a relatively small investment can bring significant savings.

Location decisions are always expensive. Solid economic modeling combined with critical strategic thinking can help you distinguish the optimum from the obvious.

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