Waters chose $10.4 billion Solectron to manufacture in Singapore its Alliance high-performance liquid chromatography system, which ramped up in the first quarter of 2006—ahead of schedule. Alliance is one of Waters most established products and has fairly predictable demand, so it's a good fit for a first-time outsourcing experience, Terricciano says. Waters is looking to trim the product's manufacturing costs and at the same time increase the system's overall presence in the Asia-Pacific region.

If other EMS companies have their way, there will be many more such leaps of faith. The $190 billion EMS industry sees the medical equipment and instrumentation market—which some estimate at more than $150 billion worldwide—as an opportunity for high growth and hefty profits. And for its part, the vertically integrated medical electronics industry, based largely in the Americas, is looking to expand its global reach without investing in overseas brick and mortar.

Clearly, it'll take more than faith. Medical companies don't have a long history with EMS. They express concerns about quality, and their product profile—highly complex products manufactured in lots of 10, 25 or 50 units per year (high mix/low volume)—isn't a good fit in a largely volume-driven business.

EMS companies also face a high barrier to entry: the Federal Drug Administration (FDA) and global standards organizations regulate medical equipment, which means manufacturers have to meet stringent quality and process controls. And the bulk of medical outsourcing is currently handled by small to midsize EMS companies that won't willingly yield to their bigger, global competitors.

However, the timing seems right for EMS companies to make a push into medical electronics. In addition to reaching overseas markets, medical equipment makers want to focus more resources on their core competencies: advancing medical technology. If this has a familiar ring, it's because just about every electronics sector that has outsourced its manufacturing has done so for the same reasons. And to date, medical companies farm out only a small portion—maybe 10 percent—of services that can be outsourced, leaving plenty of room for expansion. For example, consulting firm Technology Forecasters Inc. (TFI) expects 90 percent of networking equipment to eventually be outsourced.

The EMS industry clearly needs a shot in the arm. Profitability among the 40 largest publicly traded EMS companies is only just returning to positive territory after hanging in negative numbers for about three years, according to TFI.

"EMS companies have to be looking at new opportunities to improve their financial position," says Bruce Rayner, director of research at TFI and former editor-in-chief of ELECTRONIC BUSINESS. "Medical—no question—is a strategic initiative for them."

Gross profit margins on this type of manufacturing, known as high mix/low volume, can run as high as 25 percent to 30 percent compared with an average GPM of 10 percent to 15 percent in high-volume manufacturing, EMS companies say. And players such as $8.5 billion Celestica are looking to diversify beyond the traditional EMS strongholds.

"We are trying to reduce our reliance on IT and telecom and the cyclicality of those markets," says Steve Delaney, CEO of Celestica.

TFI estimates that EMS companies could capture as much as $10 billion in medical outsourcing business by 2009 (see chart at left).

Most players in medical outsourcing say "don't even come to the table" unless you're willing to deal with the FDA and other regulatory agencies.

"Just understanding the FDA requirements is onerous," says Dave Hockenbrocht, CEO of $167 million EMS player Sparton Electronics, which specializes in medical and other highly regulated industries. Sparton has someone on staff just to lead customers through FDA requirements, he says.

Any organization selling into the U.S. medical market has to register with the FDA, and although there's no fee for registration, regulation takes its toll. Medical products are complex to design and build and may have a product life cycle of 10 to even 30 years. If a new regulation prompts a redesign of a medical product, "it can really be frustrating," says Tony Allan, vice president of global services for the medical and instrumentation unit of $7.5 billion Jabil Circuit.

"Large medical systems can be very heavy and are too expensive to ship."
—Sanmina-SCI's Gelston Howell

Compliance with FDA regulations also means a lot of documentation. "EMS companies and their supply chain partners need to have in place reliable systems that meet or exceed traceability and documentation requirements," says Mark Zetter, president of consulting firm Venture Outsource Group.

In cases in which documentation is not up to date (for example, after a design change), EMS providers can be left with a lot of liability and are responsible for ensuring that the latest version of the product's design is being used, he says.

And the FDA requirement for process validation can be particularly vexing for an EMS company. According to Les Schnoll, Solectron's chief regulatory officer, "The process validation needs to occur when the 'results of a process cannot be fully verified by subsequent inspection and testing,'" he explains. "For example, soldering is such a process. We cannot fully verify that every single solder joint is perfect, so we have to validate the soldering process [i.e., the surface-mount technology line] to ensure that what we think occurs during that process actually does occur."

Many global medical manufacturers also seek Quality Management Systems certification by the ISO, a global standards-setting body. This comes with a price tag.

"Time and cost varies based on the size of the facility and type of work being performed," according to Schnoll. "For example, if we're doing more complex work, such as design controls, it will take longer to get [the site] certified."

Schnoll, who has conducted such assessments in Europe, says it takes an average of six months to complete a certification process, and several variables could shorten or lengthen the timeline. Some of the variables, he says, include the size of the organization (personnel), scope of activities (for example, whether design and development is included), number of facilities and the current status and robustness of the organization's quality system.

Solectron pays a third-party auditor for the certification, which includes ongoing fees. Schnoll says that, in general, costs range from the low tens of thousands of dollars for a small site to the upper tens of thousands of dollars for larger sites.

Obtaining the necessary certification still only gets you to the table, EMS players say. Medical OEMs want a clear commitment that their EMS partners are in for the long haul. Some EMS companies have taken on high-mix/low-volume business only to abandon it later.

"We've had [medical equipment] customers that have gone to the big guys but come back to us because they found themselves [treated as though they were] unimportant and [they felt] underserved," says Sparton's Hockenbrocht.

Solectron's willingness to establish a medical vertical within its business was key to Waters. "Solectron, in our opinion, was able to differentiate itself by putting resources toward the effort, researching what it takes to service us and clearly articulating their vision of the medical business," Terricciano says.

Jabil, which entered the medical market in 2000, concurs. "The first thing it took was focus from the company," says Allan. "This was a market we were going after. After that, it was all about execution." The effort has so far paid off handsomely: Jabil did virtually no medical business in fiscal year 2000; in fiscal 2006, that segment represents about 16 percent of Jabil's overall revenue, Allan says.

EMS companies that do make it to the table should then align their capabilities with medical OEMs' needs and emphasize their value proposition. In some cases, it's expertise: most EMS companies build a variety of products, whereas medical OEMs may focus on only a few. For example, Jabil was able to help one medical customer reduce a four-piece metal assembly down to a single piece of metal. "This amounted to a 45 percent to 55 percent reduction in cost, and we also managed to reduce the number of components in the system," says Allan.

Global EMS companies can also leverage their international footprints. Waters wanted to expand its reach into its fastest-growing market—Asia and the Pacific Rim—without ramping up a new factory. "One common theme we're hearing [from our medical customers] is access to emerging markets," says Allan. "They're going through the learning curve of what it's going to cost to go into a new market from scratch."

Solectron's Singapore facility provided such market access for Waters. Terricciano noted two other criteria Waters looked for in its EMS partner: new-product introduction capabilities and a locally dedicated facility. "The facility committed by Solectron was at the time available in Massachusetts and was envisioned to be a prototype shop," he says. "Factory and development floor space located in North Carolina was also made available to us if we felt the need to utilize it. We subsequently decided to consolidate all of our efforts in Singapore for assembly and test."

Savvy EMS companies will also figure out how to use the supply chain to their advantage. "Obviously, we would not have moved this product if it was cost-neutral: there had to be a compelling reason," says Terricciano. "One was management of the supply chain and the leverage an EMS can bring to the market."

That can be a challenge. The medical electronics supply chain is much narrower than the supply chains in other electronics segments: most of the components in medical devices are proprietary, and demand for nonproprietary (or standard) parts won't garner volume discounts from suppliers. (One way EMS companies reduce project costs is to procure huge volumes of standard components from suppliers to receive volume discounts.) Medical electronics companies also tend to source components locally. "All of our suppliers were in New England and other domestic areas until three years ago," says Terricciano.

"A common theme we are hearing from our [medical customers] is to access emerging markets." —Jabil's Tony Allen

That was one way Solectron streamlined Waters' supply chain. Singapore isn't the cheapest manufacturing location, but supply-chain savings offset that. "[Solectron] is assembling a subcomponent that we were previously procuring from a fragmented supply chain—they were more competitive," says Terricciano. And once EMS providers have proved their mettle, OEMs may allow them to qualify new—and foreign—suppliers, says Britt.

Jabil works around volume issues by sourcing low-volume orders from distributors that break down large volumes of components, and importing or exporting proprietary components as needed. Although this can increase logistics costs, Jabil has also been able to develop new relationships with these suppliers, which could lead to new business opportunities, Allan says.

Separate from FDA/ISO certification, Zetter of Venture Outsource Group advises EMS companies to go the extra mile for quality control. He suggests establishing systems for corrective and preventive action (CAPA), preferably as part of a collaborative effort with customers.

"The plan should begin by defining the roles of the manufacturer and the EMS provider in the CAPA process," Zetter says. "The manufacturer's team and counterparts from the EMS provider should then develop a plan to manage problems that might surface in the factory and, particularly, in the field. Each of the EMS provider's manufacturing sites should have a process for identifying and fixing problems that is coordinated with the overall CAPA plan," says Zetter.

The medical division of $11.7 billion Sanmina-SCI—one of the largest medical EMS providers in the world—implemented its own quality system several years ago, separate from the system that governs other nonmedical facilities, says Gelston Howell, senior vice president. "This system is implemented in all Sanmina-SCI medical facilities," he says. Additionally, a worldwide medical compliance management organization audits all medical facilities twice a year.

Both industry players and analysts say it's unlikely that medical electronics will unfold like other EMS markets. For instance, it will never be as heavily outsourced as IT, telecom and consumer electronics.

"Medical has some fundamental differences from other electronics: medical has life-critical systems—not the sort of thing you want to trust to any subcontractor—and there are liability, FDA and documentation issues," says Randall Sherman, president of New Venture Research. Even if printed circuit boards and other subsystems are outsourced, he says, "OEMs still want to do final assembly. A certain part of this industry will never be outsourced."

However, analysts say EMS companies can still expect to grow both globally and domestically: TFI expects medical outsourcing to increase by 17 percent by 2007. It's unlikely that medical equipment will follow other electronics manufacturing overseas. "My sense is that in our business—in the regulated space—there will be essential elements that remain in the Americas for a host of reasons," says Sparton's Hockenbrocht. "The labor content is not high enough to justify going offshore. There are regulatory issues, and a lot of companies that want to protect their IP will remain in the U.S.

"Plus," he adds, "a lot of guys would rather put their people in a car than on a plane."

Global EMS players that are willing to establish FDA/ISO-certified facilities overseas will be successful in emerging markets, many EMS players say. "Large medical systems can be very heavy—MRIs, for example—and are too expensive to ship," says Sanmina-SCI's Howell. "Plus, there are time-to-market factors: they may be on a boat for a month or so before they reach their destination." Sanmina-SCI has FDA-certified plants around the world, and the company is manufacturing in India for a large medical OEM that wants to sell into that market.

Some market watchers also say that they don't think top-tier growth will come at the expense of small to midsize EMS players. "There will always be a place in medical electronics for Tier 2 and Tier 3," says Howell. "We acknowledge that some business is not a fit for us."

For companies such as Sparton, it fits just fine. Says Hockenbrocht, "In a fight like this, I'd rather be David than Goliath."