Over the past few years, the medical device OEM space has seen an unprecedented flurry of mergers and acquisitions. According to the market research firm GE, five out of the top 30 medical device firms have been acquired since 2013, leaving just ten companies in control of 40% of the global market.

To keep up with the pace of change among their OEM clients, contract manufacturing organisations have also been consolidating. Last year, the private equity company Kohlberg & Co acquired Pexco, a speciality plastics manufacturer, Nordson acquired Vention Medical’s Advanced Technologies business and the Houston-based global services provider MedPlast acquired Vention Medical’s Medical Devices Manufacturing Services.

These deals came on the back of a number of prominent transactions in 2015 and 2016, including the merger of electronics company Molex with Phillips- Medisize, TE Connectivity’s acquisition of Creganna-Tactx, the experts in minimally invasive medical devices, and Greatbatch’s merger with Lake Region Medical to become the contract manufacturing giant Integer.

For David Kaplan, industry analyst at S&P Global Ratings, the key reason driving consolidation among contract manufacturing companies is simple; when it comes to billing, negotiating, sourcing and a whole range of other areas, OEMs would rather “work with four or five companies, than with 40 or 50,” he says. “Within manufacturing you have plastics, injection moulding, metals, all types of specialities and different materials for different processes. They might be technical, but the broader a manufacturer’s scope of speciality, the more attractive it is as a partner to a very large medical device company.”

Combine and thrive

In the companies Kaplan analyses, the role of private equity firms has been another factor driving consolidation. As owners, private equity investors will always seek growth and often the quickest way to do that is through mergers and acquisitions.

“You combine two companies, cut out some redundant cost, whether it is the management team, finance department, HR or overlapping capabilities, and you create more profit,” says Kaplan.

When searching for acquisitions, CMOs will often target an entity with a specialisation that is not widely available. Such deals offer higher levels of profitability, according to Kaplan.

“They do not want to expand into an area that is more common because those areas have much more competition and more price erosion,” he says. “If they can get something that is a little bit better protected and has some kind of barrier to competition, it will tend to be a more attractive target. They can then leverage that with their customer base more broadly.”

Diversifying what they offer doesn’t mean contract manufacturing organisations have to stray too far from their core competencies, however. When searching for acquisitions many manufacturers look to expand what they already do or seek capabilities that are adjacent to their existing specialities.

Elan Nat, another ratings analyst at S&P Global Ratings, offers the example of the 2015 Greatbach Medical/Lake Region Medical merger. At the time, one company manufactured a catheter, the other a guidewire.

“Now the two companies can provide the guidewire to be inserted inside the catheter and then into the body,” Nat says. “Complementary manufacturing capabilities are what they are really looking for.”

Of course, challenges can arise when contract manufacturing organisations attempt to acquire new companies. Major deals can involve digesting something very large and attempting to integrate and improve multiple areas of a business simultaneously. This can involve laying off unnecessary work forces, closing down plants, consolidating IT systems and changing HR policy. The larger the acquisition, the larger the risk becomes.

“A company may be acquiring another company that has itself just done an acquisition, meaning there could be multiple entities, multiple systems and things going on at once,” says Kaplan.

You combine two companies, cut out some redundant cost, whether it is the management team, finance department, HR or overlapping capabilities, and you create more profits.
– David Kaplan, S&P Global Ratings

“That is where we see the risk increasing rapidly. It is not specific to contract manufacturing: it is true of companies in general. But if you drop the ball in terms of quality, there is a risk [that] you let your customer be poached by the competition.”

Smaller picture

For some companies, these challenges mean choosing to focus on a particular specialism, which can be a better strategy that diversification and consolidation. Indeed, while the medical device industry is dominated by a small number of large consolidated companies, most businesses in the CMO and OEM space are relatively small.

A 2010 study by the US International Trade Administration, for example, found that 73% of medical device firms in the country had fewer than 20 employees, and 88% had fewer than 100.

Most of these companies are focused on new medical technology and relatively narrow therapeutic areas. Many recognise that being too spread out can detract from that focus and competitive edge.

“At times choosing to diversify could be detrimental,” says Nat. “I guess when you think about the function of contract manufactur[ers], they inherently specialise in these specific processes where they can do and produce things more efficiently than the OEMs. That is the whole reason they exist.”

Even some larger companies, such as Edwards Lifesciences, have made the case for choosing focus over diversification. Speaking at the JP Morgan Healthcare Conference in January, CEO Michael Mussallem said his company’s priority was “singularly focused” on unmet needs for structural heart disease.

“That focus helps us,” he said. “It helps us with investment decisions and prioritisation. It helps us with being deep in terms of understanding the disease burden around the world. It helps us have a deep understanding of the options.” Even if there is a case for choosing focus, for most large CMOs, the advantages of diversification will probably outweigh specialisation. In 2016, Molex, a leading electronics components supplier, acquired Philipps Medisize, its first move in the medical device space, and evidence that the market was attractive to different kinds of contract manufacturers.

For OEMs, the question becomes, ‘Are you a manufacturer for us, or are you competing with us on a given product?’
– Elan Nat, S&P Global Ratings

“One of the appealing things about healthcare manufacturing is the difficulty of it,” Kaplan explains. “Healthcare is regulated by the US FDA, the manufacturing processes are very strict and contamination is an issue. The specification and the quality are often more difficult than manufacturing in the automotive industry, for example. Because of that, the profitability is a little bit higher, so it is not surprising to see some larger manufacturing companies trying to enter this space.

“If you do try to enter it, though, you should look to start with an acquisition and then expand from there, rather than try to start up an operation from scratch. It would be very difficult to enter healthcare from fresh on the manufacturing side.”

Developing interest

Diversification is also happening not just in terms of products, but also in the services contract manufacturers offer to OEMs. In the past, medical device OEMs turned to CMOs for outsourcing labour and manufacturing, but now are partnering in record numbers at the design and development stage. A report published in 2014 from Secant Group found that product design and development was in fact the largest service segment in the medical contract manufacturing market with revenue share valued at 28.6%.

“It is obviously very efficient to have those engineers work with the device manufacturers at the start,” says Kaplan. “They have the engineering ability and deep familiarity with the manufacturing process. That means they can help design the product in a way that it is easier to manufacture, rather than just focusing on the utility of it. They know, for example, that if they design something in a particular way they can manufacturer it into fewer pieces – and more cheaply.

“I think that is the value [engineers] add and [manufacturers] now view that as essential in capturing the customer. When [engineers] get the opportunity to bid on a job, when the product is already fully designed, it becomes a very competitive process. But if they can offer to help an OEM design it in a way that will reduce their total manufacturing cost, it creates a deeper relationship with the customer and the opportunity of a higher level of profitability.”

Of course, as contract manufacturers move increasingly into design-type roles, sometimes the line between OEM and CMO can become blurred. CMOs have even been known to put their own private labels on products. “For OEMs, the question then becomes, ‘Are you a manufacturer for us, or are you competing with us on a given product?’” says Nat.

Cases of this happening remain rare, however, and do not signify any major shift in the core business model of contract manufacturers. “I think it is a very small portion of all these manufacturer’s total revenues,” says Nat. “It raises questions further down the road, but I do not think there is anything of material note at this point.”

For the time being, Kaplan adds, CMO’s are likely to continue pursuing the same proven approach of consolidation and diversification. “I think we will see more mergers and acquisitions,” he says. “After 2015 and 2016, we assumed there might be a little bit of a pause because there were big mergers and companies were digesting their acquisitions, integrating operations, [and] trying to enhance efficiencies, maybe closing down unnecessary plants if there were redundancies.

“But it has been a year or two since that wave and now we are expecting them to start acquiring more.”