Quest for ExcellenceDriving a Step Change in Medical Products Operations

2014

EditorsPeter De BoeckTed FuhrHenrik Jørck NielsenJohannes RöhrenVanya Telpis

For more information please contact Adam_Krych@mckinsey.com

Quest for ExcellenceDriving a Step Change in Medical Products Operations

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Introduction

9 Preface: Quest for excellence Peter De Boeck, Ted Fuhr

13 A new era: Driving a step change in medical products operations Peter De Boeck, Henrik Jørck Nielsen, Chris Llewellyn

Delivering what customers want in the best way

23 A healthier sense of value: Mastering DtV at scale Sastry Chilukuri, Hannes Erntell, Mike Gordon, Stephan Mohr

37 Devices and desires: Improving the manufacturability of medical products

Peter De Boeck, Henrik Jørck Nielsen, Johannes Röhren

Getting the most from the value chain

45 Beyond supplier negotiations: The future of medical product procurement

Ajay Gannerkote, Erik Larsen

55 A burning platform: Creating a competitive advantage from manufacturing footprint

Ted Fuhr, Erik Larsen, Johannes Röhren, Dannielle Sita

Contents

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Creating value through quality

71 The business case for quality: A topic for the medical products CEO agenda

Ted Fuhr, Katy George, Janice Pai

83 Winning on quality: Lessons from other industries Ted Fuhr, David O’Halloran, Camilo Rueda

89 Driving quality performance: An empirical approach Ted Fuhr, Evgeniya Makarova, Vanya Telpis, Amy Zwanziger

Going beyond the product

103 The invisible workforce: Unlocking value from field services Dilesh Bansal, Harold Brink, Erez Eizenman, Senthil Muthiah

115 The way forward: Fulfilling software’s promise Santiago Comella-Dorda, Fopefolu Folowosele, Ted Fuhr

Contacts and references

124 Authors126 McKinsey on medical products operations128 Selected McKinsey offices130 Leadership contacts

Introduction

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9Quest for ExcellencePreface

Preface: Quest for excellence

The medical product industry is changing at an unprecedented rate. Aging populations and expanding markets are driving sustainable growth. Innovative technical and clinical approaches continue to emerge. But pressures are rising just as fast. Payers are demanding higher performance and lower prices. Regulatory scrutiny is increasing. New competitors are entering the market all the time.

These trends have significant and far-reaching implications for the Operations function in medical product companies, but executives at these companies tell us that they lack industry-specific viewpoints and opinions to help them plan their own organization’s response. We have created this compendium, Quest for Excellence: Driving a Step Change in Medical Products Operations, to provide that perspective.

The first chapter in this collection looks at the challenges and opportunities facing medical product Operations as a result of the trends that are shaping the industry, and how some leading companies are significantly improving the performance of their own Operations in response.

Please keep these perspectives in mind as you read on and reflect on the potential benefits of tackling some of the more specific topics raised. With the changing industry as a background, we expect that you will find some of the issues raised to be interesting, some to be challenging, and some to be validation of your current approach. We hope that this compendium, as a whole, will allow you to consider a course that combines the most relevant issues for your organization into an integrated management agenda, and helps you find value at the intersection of these topics.

We have organized the material according to four themes that are essential to value delivery for medical product Operations today:

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� Delivering what customers want in the best way: Patients, payers, and health care providers face rapidly increasing choices, from different product technologies and different service offerings to new product varieties. Competing in this environment, particularly as pressure on health care budgets increases, demands different product design, manufacturing, and logistics capabilities. How do you ensure that your products meet the needs of all your customers, and at the right cost? Other industries, from mobile phones to automobile manufacturing, have faced similar challenges; for companies in these industries, “design-to-value at scale” has been part of the solution. We explain how leading medical product companies are now adopting the same approach to meet their industry’s particular needs.

� Getting the most from the value chain: Medical product value chains are changing. Manufacturing is moving to low-cost countries in Asia, Central America, and Eastern Europe. Companies are finding new ways to organize production. Outsourcing is on the rise, and contract manufacturers and suppliers play increasingly important roles in the competitiveness of medical product companies. Successfully managing these changes will require companies to revisit their footprint strategies, considering everything from make-vs.-buy decisions to factory locations and supplier profiles. Supplier management is another area that has not historically been a priority for medical product companies, many of which have viewed procurement purely from the perspective of price and availability. As companies are increasingly recognizing the need to access external sources of labor, technology, and innovation, they need to modify pricing and supply agreements to keep up with their changing markets and to reap the benefits of improved supplier collaboration. We look at how companies are expanding and “upskilling” their external activities to achieve these aims.

� Creating value through quality: Many medical product companies have carried out major quality improvement programs over the past decade. Some of the benefits of these efforts have been slow to materialize, however, and the industry continues to see a steep increase in adverse events and regulatory actions, combined with unwanted attention on quality issues from patient groups and the media. New data reveal which quality practices really make a difference, and which do not.

11Quest for ExcellencePreface

� Going beyond the product: Modern medical products must operate as part of a system that includes hardware, software, and service offerings. We look at the challenges that companies face in managing the increasingly important software component of their products, how this can damage or enhance the value of a product, and how the best companies are responding. We also explore the opportunities to gain a competitive edge through improved field service performance.

Finally, we offer the reader a number of references to books and articles on operations topics that we have published elsewhere, either addressing related industry sectors or taking a cross-industry view.

* * *

We hope you enjoy this compendium as a source of inspiration for your own operations agenda, and we look forward to a continued discussion on the topics you deem relevant to your company’s journey.

Peter De Boeck and Ted Fuhr on behalf of McKinsey’s Global Medical Product Operations Practice

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13Quest for ExcellenceA new era: Driving a step change in medical products operations

A new era: Driving a step change in medical products operationsPeter De Boeck, Henrik Jørck Nielsen, Chris Llewellyn

The medical devices industry is facing unprecedented challenges. Operational excellence will be a critical weapon if it is to overcome them.

Ten years ago, the medical product sector enjoyed enviable conditions. A portfolio of relevant technologies and good relationships with clinicians were enough to sustain growth. Today, the game has changed. Significant innovations are getting harder to come by, and in the face of spiraling health care costs, providers are increasingly emphasizing the cost effectiveness of treatment over the adoption of cutting-edge technology. This change is calling into question the industry’s entire cost structure and business model.

Health care reform has been under way for a number of years, with a focus on increasing both the quality and the availability of care. More recently, changes in macroeconomic conditions have made it even more obvious that health care spending cannot continue to rise at historic rates (i.e., outstripping economic growth by two percentage points every year) (see Exhibit 1). Attention has shifted toward improvements in productivity.

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For medical product players, the combination of maturing product categories, increasingly sophisticated customers, and a slowdown in the rate of spending growth has hit like a perfect storm. New products are getting more expensive to develop and to sell—a consequence in part of tighter regulatory burdens and the rising cost of acquiring new technologies—while prices are sustaining increasing downward pressure.

The decrease in total returns to shareholders and in profitability comes as no surprise. And there could be further decreases to come. We believe that, even though health care providers have already proactively reduced costs, the pressure to keep reducing costs will only increase as cost containment mechanisms begin to take effect over the next three years—for example, we anticipate a squeeze on the growth rate of reimbursement per procedure. It is hard to imagine this will not have a knock-on effect for the industry.

Exhibit 1

Health care expenditure growth scenariosProjected potential healthcare expenditure growth by 2040Health expenditure as percent of GDP

Source: Projections of GDP share of health in Organisation for Economic Co-operation and Development countries, Sustainable Health Systems: Visions,Strategies, Critical Uncertainties, and Scenarios, World Economic Forum, January 2013

1 Applies a 2.5% probability of a country being an additional one standard deviation higher in any given year compared with the low case2 Based on extrapolation of linear regression analysis of historic health expenditure for all available years

11.0 10.6 10.4 10.3 10.0 9.9 9.7 9.7 9.7 9.1 9.1 8.9 8.4 8.4 8.27.5

5.6

2.31.3

6.3

4.1

15.7

19.5

13.5

20.45.3

Finland

2.4

Ireland

10.0

18.0

Spain

11.6

16.5

UK

11.0

13.9

Norway

4.4

12.1

14.8

15.3

19.2

4.7

4.3

12.9

Switzerland Belgium DenmarkPortugal NetherlandsGreece Sweden ItalyGermany

15.4

21.0

Austria

12.5

15.2

France

16.3

19.1

2040 high1

2040 low2

2007

15Quest for ExcellenceA new era: Driving a step change in medical products operations

When combined with a lower consensus forecast for revenue growth, these dynamics suggest that the industry is moving toward a more mature stage in its life cycle. Many CEOs are now asking where they will find the next S curve of growth. They may be looking in vain. Certainly, plenty of micro S curves will present themselves in areas of new, niche technology, but we are skeptical about the chances of the industry as a whole finding any kind of magic bullet.

The gauntlet for Operations

The industry has been pulling many levers to address its challenges, including focusing on reduction in COGS (see Exhibit 2). However, its ability to create the financial headroom it needs in order to reinvest in new business models, commercial capabilities, and growth initiatives by doing this is declining. Meanwhile, more is always being asked of Operations teams. Companies are testing new business models that include, for example, higher sophistication in deployment of consignment and trunk stock, and differentiation among clients when planning logistics processes and service levels. Some new products will come with heavier burdens for Operations, like the use of Internet technologies to monitor patients, update software, or track stock. And as their customers pay more attention to financial as well as clinical measures of performance, Procurement plays an increasingly critical role in sourcing atypical external suppliers to support these needs. Finally, it is more important than ever to ensure that every new product creates value in the market and complies with regulatory requirements, raising the bar for the role that Operations plays in product development.

Seven institutional capabilities that matter

The new reality calls for new approaches and new solutions. A stronger Operations function will play a central role in distinguishing future winners from losers, just as it has done in the automotive, consumer goods, and, more recently, pharmaceutical industries. And as was the case for companies in these other industries, medical product companies will need to master a broad range of capabilities and—simultaneously—deliver on them if they are to institutionalize high-performing medical product Operations functions. It won’t be enough, for example, to simply boost output by overstaffing production lines, or to pour resources into emerging-market production networks while ignoring the

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performance and utilization of those at home. Companies must do both, which will call for thorough institutional capabilities to master these tensions.

If we look across companies and their management priorities within operations, we see seven themes that distinguish winners from followers. No single company masters all of them, but we strongly believe that the most successful companies will be the ones that successfully develop capabilities in the largest number of them, rather than those that focus on just a few.

Embedding a deeper understanding of customer needs into every product. Who is the purchasing decision maker? What are their current needs and wishes? How are their buying habits changing? What can an end-to-end pathway mean for our product offering? As medical product companies revisit their medium- and long-term strategies, they will need to find better answers to questions like these.

Exhibit 2

Breakdown of changes in medical product costsMedical product industry1 cost breakdown, 1995–2010Percent of revenue2

Source: Datastream; PharmaLive report, 2011; S&P Capital IQ; expert interviews; McKinsey analysis

1 Includes the 71 largest companies globally for which >90% of revenue comes from medical products2 Numbers may not sum to 100 because of rounding3 Includes depreciation and amortization

13 17 17

35 37 35 36

12

2010

40

1995

40

8

43

2005

77

2000

8

44 –5

1

–1

5

Absolute percent-age point change,1995–2010

Earnings before interest and taxes

COGS

R&D

SG&A and other3

0

–1

0

Absolute percent-age point change,2005–2010

1

17Quest for ExcellenceA new era: Driving a step change in medical products operations

While some medical product companies have experimented with techniques like design to value, plenty more have never heard of it. Hardly any in the industry have institutionalized these methods to the point where they systematically check product attributes against customer needs and competitor offerings, consistently look for more cost-effective manufacturing approaches, or balance the value of product features against the cost of delivering them.

Continuously improving product and process quality while driving down cost. Customers are demanding products that offer better performance and quality but cost less. Meeting those needs will require companies to continually innovate in the design and manufacture of both new and existing products.

Many companies have run lean programs, but few have been able to get beyond short-term cost cutting or the application of a limited set of tools to drive a change in the mind-set of all their employees. Creating a culture of continuous improvement is a difficult and long-term process, but it has been central to the success of leading companies in many other industries. It is worth noting that such a capability requires great sophistication if a significant share of production is done by suppliers. Few companies have pushed continuous improvement so far that a problem caused by a supplier’s production process but detected only at the assembly line can be traced, contained, and eliminated, for instance.

Deploying assets and resources where they matter most. As emerging economies become more important—as markets, sources of supply, and as manufacturing locations—justifying the continued existence of plants in high-cost regions such as Western Europe might be difficult. However, companies grappling with such a decision should be aware that the situation is nuanced. Proximity to key markets may be an important factor for some manufacturers and some product categories, for example.

To make the right network footprint decisions, companies will have to understand the potential of each market. Where relocation is needed, they must be bold and purposeful about it. Aggressive relocation strategies have been demonstrated to create almost twice as much shareholder value as more moderate attempts.

Moving from product delivery to solution provision. Many medical product companies are already making the transition from product maker to solution provider. More will follow. Health care organizations are increasingly looking for vendors that can support their products in deeper and more comprehensive

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ways, integrating their offerings into the customer’s infrastructure, and becoming a partner rather than a simple supplier.

Closer relationships with customers will be important in many ways. In addition to looking for ways to differentiate themselves from the competition, medical product companies must find ways to generate better insights into changing customer needs. Examples of differentiating factors beyond the changes to the product itself include training, data analysis, and risk sharing. But the sky is probably the limit given the complex stakeholder landscape in which medical product companies work. We have recently seen a number of companies increase their focus on more user-friendly software and outstanding field service, just to name two examples.

Taking a total-life-cycle-cost perspective. With increasing pressure on quality and service for customers, medical product companies must move beyond viewing support and maintenance as a cost of doing business. Successful companies optimize performance across the entire life cycle of the product, from development to in-service maintenance. By improving remote support and applying advanced analytics to manage field service, companies can significantly cut costs while delivering superior value to customers through shorter waiting times and on-the-spot resolution of issues. Some companies go even further, developing active feedback loops among R&D, Product Development, and Field Services to accelerate product improvements and uncover new sales opportunities.

Working more closely with suppliers. The medical product industry has one of the most fragmented supplier bases of any industry. Whether the objective is to develop new products or to ensure profitable production and delivery of existing ones, companies face a formidable challenge in managing procurement costs and supply risk while ensuring component quality, IP compliance, and access to new innovation within the supplier base.

Leading companies are now reducing their direct procurement costs by partnering closely with select suppliers of strategic parts and technology. The best of them are working together to improve production processes, tap into new sources of knowledge, and involve suppliers in product design choices. At the same time, these companies go to great lengths to expand their supplier

19Quest for ExcellenceA new era: Driving a step change in medical products operations

base for nonstrategic parts in order to drive down prices and eliminate single-sourcing risks.

Differentiating the product offering. Low-cost products are becoming a critical battleground in the medical product sector. New competitors, often based in low-cost regions, are successfully attacking established players by offering less expensive, simpler products with fewer features or lower quality and specifications. Where they aren’t forced out of these segments, established players are reacting by developing their own low-cost offerings for price-conscious customers. The very best companies are learning lessons from the automotive sector: they are reusing existing technology, production platforms, and supply chains to deliver scale advantages across both premium and low-cost products in order to successfully beat the low-cost attackers at their own game.

* * *

At the very least, each of these capabilities will rely on high-performing Operations for its success, and many of these are firmly rooted in the function. The medical product industry can find inspiration in other industries like automotive and retail; there, companies including Toyota and Wal-Mart have made operational excellence an art form, one that brings a true competitive advantage.

In the rest of this compendium, we’ll take a deeper look at the importance of some of the capabilities described here.