Medical Electronics Manufacturing Fall 1998
OEMs may find outsourcing is the answer to today's challenging electronics manufacturing questions.
Ty Griffin and George Lawrence
Today, many vertically integrated original equipment manufacturers are questioning their commitments to performing all levels of manufacturing internally. This is especially true for vertically integrated OEMs in the medical device industry. Technical advances and market-driven cost constraints are major factors in an OEM's evaluation of core competencies, and the transition from pin-through-hole to surface-mount (especially fine-pitch) technology requires a significant capital investment for both equipment and technically capable personnel. In addition, the accelerated pace of communications via E-mail and the Internet is forcing manufacturers to seriously reconsider how to meet their customers' higher expectations. A potential solution to these challenges is outsourcing, which can be a viable alternative to internal manufacturing.
A technician inspects a printed circuit board. Nonvalue-added functions and noncritical time functions are performed offline to maintain high-production line velocity.
Outsourcing Comes of Age
Although some OEMs of high-volume consumer products already outsource to both domestic and offshore providers of electronic manufacturing services (EMS), many others still manufacture devices in their entirety because of the complex and high-mix nature of their product lines. Historically, internal manufacturing has been a necessity for OEMs in the device industry because of FDA's stringent quality system regulation (QSR) requirements and the tendency toward smaller lot sizes. In the past, it seemed that contract manufacturing was better suited for high-volume applications.
Figure 1. A comparison of vertical (in-house) and virtual (outsourced) infrastructures.
But the EMS industry has progressed from the "board stuffer" days of simply handling an OEM's overflow assembly. Full-service EMS companies can provide everything from new product design and design for manufacturing (DFM) to hub-centered warranty service and field-service depot repair in partnership with major overnight carriers. OEMs are beginning to assess their core competencies and to determine which, if any, manufacturing processes should continue to be performed internally and which should be outsourced. Figure 1 illustrates the transition of manufacturing services from its previous vertical niche to its outsourced stage.
Step One: Financial Analysis
The goal of outsourcing is to accelerate the development of a product from the raw materials stage to a completed product and then to the final user. The desired end result is, of course, optimum financial performance for the company. Consequently, the first—and perhaps most important—step in the evaluation process involves a comprehensive financial analysis of asset utilization and return on investment at every level (see Figure 2). This analysis should include design assistance, subassembly-level manufacturing, final product configuration, distribution, and warranty/field-depot repair services.
Figure 2. Steps for evaluating whether to outsource electronics manufacturing.
In this financial evaluation, it's critical to determine the relative costs of outsourcing compared to the fully burdened internal costs of manufacturing. To determine the total acquisition cost, the OEM must first decide what level of the manufacturing process (for example, printed circuit board/cable/wire harness assembly or full final configuration and warranty/repair) may be outsourced based on the nature of the product. The total acquisition cost to perform that level of manufacturing can then be determined.
A new manufacturing line cannot be expected to be as cost-effective as an operational line, largely because an EMS provider will first have to establish a capability and then produce, fine-tuning the manufacturing process along the way. While this fine-tuning can be time-consuming and expensive, it's important to remember that EMS providers can mitigate these cost inefficiencies by providing already trained staff and validated processes, as well as by reducing time to market.
It's also important for OEMs to consider that EMS providers must charge for nonrecurring engineering expenses, which may cover the cost of a variety of materials and services—from fixtures and stenciling to DFM and design assistance. Because these costs can sometimes run in excess of $100,000, the EMS provider should explain why each associated cost is necessary and how it will be accounted for (for example, if it will be amortized in the cost of the device or billed separately).
Calculating Direct and Indirect Costs
To calculate total acquisition costs, an OEM must first know the cost of direct labor (including the payroll burden) and the material content of the assembly. A more difficult task is determining the indirect costs associated with the manufacturing. Several areas to consider are plant and equipment use, cost of inventory at the component level, inventory turns, and support functions such as supervision, engineering, purchasing, and materials handling (see Table I).
|Labor||Material||Supporting Cost Structure|
|Direct cost with payroll burden|
Cost of capital (dollars invested vs. inventory turns)
Issuing from/returning to stock
Plant/equipment depreciation, lease cost, and maintenance
Materials invoice processing
Table I. Factors affecting total acquisition costs.
Plant and equipment considerations are fairly straightforward. The key is identifying overhead absorption and, if manufacturing stays internal, ascertaining the levels of incremental cost necessary to support future needs. For example, two processes with significant equipment costs are surface-mount and in-circuit testing. As a result, the analysis of current and future capabilities in these areas may have a substantial impact on cost. If it's likely that new, advanced interconnect technologies will need to be adopted and skilled technicians hired or existing employees retrained, OEMs need to take these costs into consideration.
Inventory costs and turns are also important factors. OEMs often underestimate the cost of inventory when determining internal costs. Various numbers bruited about the electronics industry place carrying costs of inventory at between 1.5 and 2.5% of the average inventory dollar level per month. That's 18–30% annualized, or $1.8–$3.0 million per $10 million of inventory. This figure includes the cost of capital, vendor management, purchasing, receiving, inspection, storage, and issuing and returning material to and from the manufacturing floor.
Even companies that can finance inventories through internal cash flow have what's called an opportunity cost. In such cases, cash is invested in a fairly illiquid asset and may provide a better return on investment if allocated elsewhere (for example, in research and development or sales and marketing). In this respect, outsourcing can provide a financial advantage. By having the entire materials function focused on procuring, receiving, and inspecting subassemblies rather than on thousands of items at the raw materials level, personnel capacity can be increased. This can reduce the need for additional staff as the company grows, and purchasing will have fewer suppliers with which to interface. The resulting higher productivity can equate to higher profits.
Other support functions that are equally affected are process engineering and assembly documentation. Again, these resources could be reallocated or the level of future requirements for additional resources decreased.
Once these costs are calculated and understood, the OEM can decide whether to make or buy. If the decision is made to outsource, an OEM can then begin the search for a compatible EMS provider that can best replicate the product.
Evaluating EMS Providers
Organizations such as the Institute for Interconnecting and Packaging Electronic Circuits (Northbrook, IL), research organizations such as Technology Forecasters (Alameda, CA), and annual directories in electronics magazines are good sources of information on EMS providers. But before sending out surveys and requests for pricing, an OEM should narrow the list of potential EMS providers to those that would be a synergistic fit. An EMS provider with experience in the medical electronics industry, for example, will not only have knowledge of the QSR, but will also be able to perform critical component tracking and understand the importance of keeping device history records.
Given the nature of the products in medical electronics, logistics are also important. For instance, it's easier to conduct concurrent engineering support and evaluation when the OEM and EMS provider have manufacturing facilities within a two-hour flight time. Being geographically close also enables many issues to be resolved in person, which—despite all of today's electronic communication—is still preferred by many manufacturers. Other services that can be valuable include: design assistance and prototype capabilities; value engineering (with the product manufacturing cost savings returned to the OEM); expedited purchasing that requires only one purchase order for procuring assemblies); complaint handling (both hot line and complaint closing in accordance with the QSR); material management experience; and depot repair for prompt handling of field returns. Additional services that may be beneficial include spares provisioning for field-support teams, defect analysis expertise that can be leveraged on the production lines by field repair teams, decontamination services for returned devices, and product life support.
Planning for Future Capacity
Today's fine-pitch components drive the need for advanced technical capability, both from an equipment and personnel standpoint. As a result, it's important that EMS providers be up to speed with the latest technology when the OEM's next-generation product is ready for manufacture. OEMs must evaluate any immediate capacity constraints the EMS provider may have, as well as its overall growth plan to accommodate additional capacity. The wise OEM should ask the EMS provider what percentage of total capacity the newly outsourced product will require, as well as the percentage of capacity that's available for an increase in production.
Here an operator loads a high-speed surface-mount pick-and-place system with component cartridges filled offline in an inventory staging area.
The distinction should also be made between EMS providers focusing on high-mix, low-volume production versus those specializing in low-mix, high-volume programs. Low-mix specialists are typically high-volume assemblers and thus often use linear continuous flow manufacturing (CFM) techniques. CFM can be thought of as a single pipeline optimized for speed by integrating all elements—material flow using JIT techniques, assembly, and testing—into a single line. The advantages for high-volume production are obvious.
To achieve high speeds and volumes for high-mix assembly, a hybrid CFM technology called asynchronous process manufacturing (APM) is used. APM is a nonlinear process in which small, highly trained teams set up process equipment off-line and move products through the assembly process to the next available workstation—not necessarily in the same line—according to a high-velocity algorithm. APM increases throughput by decreasing setup time, standardizing work centers, and processing smaller lot sizes. Kit-pull-to-packaging turn time is decreased from 21 days to an average of 5, regardless of whether an order is for 2 or 200 boards. In addition to reduced manufacturing costs, APM improves the OEM's time to market, enabling it to capture a larger market share with a higher-quality product.
With potential sales of some devices running in the tens of millions per month, reducing time to market is critical for medical OEMs. Yet even the fastest APM facility can't produce a product before it's designed. Consequently, some EMS providers now offer innovative solutions that help speed the design process, especially in the area of prototype production. For example, EMS providers that use a fixed-price manufacturing matrix can determine the price of a prototype printed circuit board based on design complexity, thereby eliminating the time that would be spent processing labor and materials quotations. A fully tested PCB from the OEM's bill of materials and schematics can be produced in days instead of months.
Costing and Facility Audits
Just as EMS providers use different costing models to charge for their prototype services, they also cost their products in many ways. Some companies use a multiplier against the component costs, while others use a breakout scheme that exposes all costs, with a definite markup called out. Activity-based costing, time-based costing, and contributive margin analysis are all commonly used models. Ultimately, the most important cost of concern to OEMs is total acquisition cost. In the long run, understanding and comparing the differences between the OEM's and the EMS provider's total acquisition costs will provide the most accurate and comprehensive analysis.
The final step in determining whether to use an EMS provider should be auditing the facility. The OEM or a qualified independent consultant should conduct the audit. This audit ensures that the systems and processes are consistent and compliant with QSR and other specific requirements.
Making the Decision
In today's medical device industry, there seems to be no right or wrong answer to whether to outsource electronics manufacturing. However, the evolution of contract manufacturing from board stuffer to manufacturing services provider has made outsourcing an attractive alternative. Fortunately, OEMs can easily decide whether to continue to be vertically integrated by conducting a solid financial analysis to determine the internal cost of acquisition necessary to produce a product. If the decision to outsource is then made, OEMs can choose from providers based on the OEM's product, marketing, and financial strategies. If both the OEM and the EMS provider are committed to the relationship, long-term success is likely to follow.
No matter which decision is ultimately made, it's critical that OEMs at least evaluate the outsourcing option. Given the competitive nature of today's world economy, those OEMs that avoid evaluating their core competencies may indeed find themselves isolated—and in business difficulties. Instead, through some outsourcing, companies can realize greater cost-effectiveness and better cash flow, as well as the freedom to invest strategically.
Ty Griffin and George Lawrence are marketing managers of Rocky Mountain operations for EFTC Corp. (Denver).