The impact of consolidation on the medtech industry

Karl Freimuth: There has been significant merger and consolidation activity in the global medical device supply chain over the last decade.  

OEMs: Abbott – St. Jude Medical. Zimmer – Biomet. J&J – Depuy Synthes. Becton – Carefusion & Bard. Medtronic – Covidien and recently Mazor Robotics. Smith’s Medical division announcing a planned divestiture from Smiths Group. 

Contract manufacturing organizations (CMOs): Orchid – Nordic Capital. Avalign – Linden. Paragon – NN. Integer Advanced Surgical & Orthopedic – Viant. Micro Group – TE. Cadence – Kohlberg. Resonetics – GTCR. Spectrum – AEA. Tecomet – Charlesbank. 

What impact is M&A consolidation activity having on the medtech supply chain?

Hunter Craig: We often see FTC-driven divestitures create some interesting acquisition opportunities in the proprietary device space.  If you’re a larger CMO player of scale, it also represents an opportunity because OEMs are trying to consolidate their supplier base. If you’re a smaller supplier on a longer tail, and you know you’re less specialized or qualified, it’s a real risk.

Kevin Cordero: Our company has smaller “speedboat” Divisions in the $100 million range and large billion dollar Divisions. Consolidation can actually be advantageous because some competitors in our smaller markets are getting acquired and becoming more centralized within the new/larger organizations.  This results in less focus on their customer bases while we’re staying decentralized and focused on our core markets.

Chris Witham: It has really created an opportunity for Motion Dynamics as what I would call a tier 2 or tier 3 supplier.  The end customer might view some of these roll-ups as competitors and so they don’t want to source any new programs with them. It has created an opportunity for us to actually bid on more work, so consolidation has worked out well for us.

Steve Sundberg: Consolidation at the OEM level has provided opportunities for us. We are fortunate enough to be considered a strategic, or key supplier by some of the players initiating the acquisition. I can think of two cases where this opened the door for us to begin serving the acquired firm where we previously weren’t doing so.

Karl Freimuth: The consolidation trend has also developed several new non-traditional diversified industrial entrants who are building out significant medical device platforms or contract manufacturing organizations. Some of those organizations include NN Corporation, Molex, Interplex, Nordson, and Freudenberg. Are these non-traditional diversified industrial players who are trying to get into higher growth markets making material inroads in the medtech space?

Hunter Craig: Industrial companies have emerged as super aggressive acquirers in the space. They’ve crossed the bridge of getting comfortable with the medtech realm.  Compared to general industrial exposure, medical businesses have more stable growth, higher margins, and better returns on capital.  Industrial acquirers typically start small in the medtech space and then realize that relative to the rest of their core business, they can execute the same playbook in terms of core capabilities and competencies but be indexed to the benefits of the medtech space.

Kevin Cordero: Consolidation hasn’t affected us much at all from this perspective. Hospital systems are looking to deal with larger vendors that have a broad product platform. Fortunately, we’re in a position where we do have that capability to work across divisions within the company to execute deals with customers based on implants and capital equipment and so forth. So there are advantages to being tied to the scale of a larger manufacturing organization.  The customer tends to identify where our needs are in terms of looking to fill product portfolio gaps and adding different technologies to be able to better serve the hospitals.

Karl Freimuth: What demands are medical device customers placing on contract manufacturers in terms of engineering support, design for manufacturability, customer acceptance rates, quality requirements, on-time delivery, etc?

Chris Witham:  This year we’ve done 34 validations relative to our first one five years ago. That all gets down to quality. It’s a verification of the quality of product that you’re going to provide to your customer. That’s created a ton of work for Motion Dynamics because each customer has a unique requirement for validation.

On-time delivery has probably been our number one focus this year. I compare things to automotive where the expectation is on-time every single delivery. A few years ago there was a lot more flexibility in delivery times and we didn’t get held accountable if we missed. That has really changed. We’ve made significant improvements in our business model where we’re now north of 98 percent with on-time delivery where we used to play in the 60 percent range. And that’s just not acceptable anymore.

Lastly, one of the biggest financial struggles we see is a push out of terms of payment.  Typical for us two years ago was 30 days from the major OEMs. Now you’re going to have to accept 90 days.

Steve Sundberg: I agree with Chris in regards to the need to upgrade the talent in our quality organization. Five years ago, our Chicago location had one Quality Engineer along with our Inspectors. The Quality Engineer did everything from creating inspection plans to documentation control.

Today we have multiple Quality Engineers, multiple Document Control specialists and have increased the number of Inspectors we have. This has been driven not only by increased scrutiny the FDA is placing on Tier 2, and lower, suppliers, but also on the complexity of the products we are being asked to manufacture.

On-Time Delivery has always been an important metric. The larger OEM’s have a definite cadence to their product launches, which makes it even more important today. You don’t want to be the reason a launch of a new system is being delayed.

Karl Freimuth: When you evaluate prototyping opportunities and next-generation platforms for the next chapter of growth for medtech CMOs, how important is it to be on the front end of prototyping those platforms such that you can’t be displaced?

Chris Witham: That is literally our business model. We’re very heavily weighted around engineering experience.  Our entire business model is built on speed and being able to do things other businesses cannot do. The model is all about speed, and being able to get iterations to engineers very quickly so they can do multiple iterations of their design versus just one. That is truly how we roll because once you get on a component assembly and it goes through the validation process through the FDA, unless you make a big mistake you’re on there for the life of program.  That’s how we grow the business.

Hunter Craig: We’re able to be an efficient partner for medtech OEMs. We can help bring their products to market through clinical development. For regulatory reasons, CMOs end up being the sole supplier and spec’ed in on component products which is a nice place to be. In addition, we have seen a greater number of people spin out from Medtech OEMs and start their own companies, which are great customers for CMOs. The public and private equity markets have been deploying capital to support those emerging companies and that dynamic is as robust today as it’s probably ever been.

Steve Sundberg: Until the last couple of years, OEMs were comfortable having their prototypes done at shops that specialized in quick turn-, small quantity prototypes. Today, most will tell you they would prefer prototypes be done with the company that will bring it to production. The challenge for us is having both business models operating under the same roof. We needed to adjust a lot of our standard process in order to strip out lead times and overhead. Prototypes don’t need to have the same Quality procedures applied to them. We got it figured out, but it took a couple of iterations to get it right.

Karl Freimuth: There’s a significant proliferation of small to midsize medtech OEMs that could be potential customers for CMOs.  How are CMOs taking advantage of consolidation activity at the OEM level?

Hunter Craig: The medtech CMO space is probably one of the most fragmented markets we’ve come across. We work with multiple executives from Abbott who have communicated anecdotally that Abbott probably manages two to three hundred CMO companies across their supply chain, which creates an incredible amount of complexity. So you’ve got the organic growth tailwinds of underlying medtech volume growth and a narrowing of vendors to largest CMOs plus you have a robust follow on acquisition opportunity where you’re in position to acquire and provide a broader set of services for the big OEMs.  At the end of the day, that’s kind of what they’re trying to solve for here.

Access the entire Medtech M&A report by clicking here.

For a pdf version of the report, please reach out to Olga Jewusiak at jewusiak@livingstonepartners.com.