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Adapt or die

Tom Toth
2 December 2009

Companies need to evolve faster to remain at the top of global pharmaceutical manufacturing.

For years, healthcare has been one of the most profitable sectors in industry. However the world is changing, and fast. Generics manufacturers are growing and strengthening, the capabilities of innovator manufacturers is building rapidly in low cost regions, and consumers are demanding lower costs. Incremental change is no longer an option and to stay at the top global pharmaceutical manufacturers need to restructure more radically, much faster and adapt experience from the automotive and electronics sectors.

The industry is faced with unprecedented threats from all sides; the enormous costs and timescales associated with bringing an innovator drug to the market, the growth of generics manufacturers in the developing economies and emerging markets, and cost pressure from the healthcare systems and big global customers.

These threats to competitive manufacturing are intensifying:

  • China is already the world's largest producer of the raw materials used in medicines and can manufacture at a material cost advantage of 20-25% to that of producers sourcing from the US and European economies

  • A recent major study commissioned by the Generic Pharmaceutical Association indicates that as a consequence of the Hatch-Waxman Act in the US, using generic pharmaceuticals has saved the American healthcare system more than $700 billion over the last decade and over $120 billion in 2008 alone. The global generics market is projectd to grow by twice the compound annual growth rate of the pharmaceutical market through to 2013, which will put further top line pressure on the major pharma companies

  • Although China and India accounted for only 2.5% of global pharmaceutical sales by value in 2006, in volume terms this was the equivalent of 25% of the global market and was largely supplied by local generics. This indicates that the global players are not responding fast enough

  • Whilst the size of the generics market and the number of generics manufacturers is growing, the capabilities of the emerging markets in drug and device R&D, cGMP, reverse engineering and lean manufacture are also developing rapidly

  • The combination of US and European healthcare systems shifting to competitive tendering and the move by big customers such as Wal-Mart to apply intense pressure to reduce costs of procured drugs and devices is having a major impact, with drug prices expected to decline by 7-15% per annum.

These cost and market pressures are forcing large pharmaceutical businesses to drive their manufacturing operations even harder to respond to threats to market share and to generate the cash to fund new product development. The question is are manufacturers responding radically and fast enough?

Manufacturers in other sectors have responded more rapidly to the changing global economy

The large pharmaceutical companies have extensive global manufacturing footprints, proliferation of SKUs (stock keeping units) across their product range and complex supply chains which contribute to a fundamentally higher cost base and overhead structure than the generics or contract manufacturers. Most have been engaged in rationalisations over the last five years but given their ongoing footprint targets there is still excess capacity.

Unlike automotive, the large healthcare sector businesses are predominantly centred in domestic, high cost economies, with on average only around 20% of their workforce based in the emerging markets. This compares with nearly 50% for Volkswagen. Similarly, over the last 8 or so years over 50% of new automotive plants were built in the emerging markets and recent studies have also shown that for Western European automotive suppliers, 85% of all plants are foreign. This level of structural change does not happen quickly but it is driven by clear strategic drivers of proximity to market and relentless cost reduction.

Our experience of working with pharmaceutical and medical device contract manufacturing organisations and generics manufacturers reveal how closer aligned they are to best in class automotive and electronics manufacturers:

  • They are leaner, more responsive and agile - generics manufacturers can introduce and ramp up a product in sufficient volume to claim a market share of 85% in just 10 weeks after a patent expires

  • They have a substantially lower cost base - generics manufacturers in the emerging markets typically have a 30-40% cost advantage. With lower gross margin targets, the generic produced drugs up to 80% less than brand name drugs

  • The global contract manufacturers have considerable leverage with material and component suppliers to strengthen their competitive edge. They have facilities in low cost regions and change the location of manufacture for a product through its life cycle; close to R&D during technology transfer and volume ramp up, and in the lowest cost location once mature.

We have also found that many of the large global pharmaceutical manufacturers do not have the organisational or supply chain structures that would readily integrate with external manufacturers nor the organisational experience or culture to collaborate openly on technology transfer. This makes establishing partnerships, external supplier networks and moving to a more diverse structure problematic. Shlomo Yanai, president and chief executive of Teva, is sceptical of the trend for big pharma companies to move into generics. He wonders: "How can you merge two different schools of thought? The difference in thought and approach is so big that you have to create very separate structures." This is what most pharmaceutical manufacturers have done, with others preferring a more integrated approach. The best examples would be Novartis with Sandoz on the one hand, and the more integrated model of GSK on the other.

Pharmaceutical manufacturers must adopt a more diverse and flexible structure

The question of whether manufacturing is a core competence for pharma and medical device businesses and whether or not any part of the manufacturing process offers real differentiation or an entry barrier has already been answered by the huge growth of contract and generics manufacture. Our own experience would suggest that 80% of drug or device products contain no unique or critical manufacturing capability that could not be outsourced.

Then there're the growing moves to outsource research and development, indicating the sector is moving through the same maturity curve as most of the other large manufacturing sectors have been through over the last 10 to 15 years.

Business as usual is not a sustainable option and our view is that responding to the threat from generics is only part of the picture and must be addressed as one component of a broader and more radical transformation strategy that positions the business to reduce its cost base in an integrated way. Furthermore, we believe that the large healthcare manufacturers must move towards a more diverse and flexible structure with a global network of product development, supplier, manufacturing, logistics and sales and marketing partners in closer proximity to their growing markets and their competition.

There are many frameworks for helping businesses develop transformational strategies. The question is what are the key insights and learnings that global pharmaceutical businesses can leverage from other industries that will enhance their success and reduce risk.

Develop your strategy with insights and experience from other sectors

PA has been active in the manufacturing sector for over 30 years helping global aerospace, automotive, electronics, consumer and healthcare clients develop and implement business and manufacturing strategies to achieve transformational change in their businesses. We understand that in addition to having a robust development process the most effective strategies reflect and incorporate a critical internal perspective of the business, thorough and current external knowledge, and modelling tools that can handle the complexities and scope of a global business:

1. Rethink and challenge what is core to your business right across the entire supply chain

This starts with understanding the new realities, where you market will be and the impact this will have on the dynamics of your business. It means knowing what you must own, what you can afford to own and it requires breaking down and questioning every aspect of the end-to-end supply chain to understand its criticality to success. The challenges are to keep it objective, to guard against the internal protectionism and to bring in expertise and learning from outside the sector to demonstrate what is possible.

Automotive and aerospace sectors have demonstrated that the highest levels of product quality can be maintained while outsourcing. The assembly of cars such as the BMW X3, Saab 9-3 Convertible and Porsche Boxster have been contracted out to 1st tier suppliers, and the purchasing and supply operations of the OEMs (origianal equipment manufacturer) have built knowledge and experience of how to operate effectively in such a collaborative structure.

2. Assess and understand external capabilities

Knowledge of the capabilities of material suppliers, third party product developers, consults, contract manufacturers, logistics providers and generics businesses in both the developed and emerging regions is vital to understand the potential scope of business diversity that can be achieved over the longer term.

This knowledge base is valuable and must be managed as collateral for the business to inform and adjust the strategy over time. Fact-finding trips every two to three years must be replaced with on-going knowledge building using regional resources with audit and evaluation experience.

3. Address the organisational implications and constraints

Identifying strong external partners is essential but not enough. In our work helping clients extend product development and supply chains into emerging markets, we have concluded that organisational change has to take place before a business can collaborate effectively with a diverse external network of suppliers.

Detailed process mapping of both the internal business and external suppliers is required as a basis to identify and optimise the touch points and the interfacing functional processes all the way through the respective product development, commercialisation and supply chains not only to ensure integration is effective but also so it is efficient, lean and the capabilities of partners are fully utilised.

4. Establish your partners with a long-term perspective

In the quest for the perfect partner, businesses frequently overlook the longer-term potential of the supplier and the return that can be generated against the investment to align quality, validation and regulatory processes.

Businesses such as Toyota that have succeeded in establishing reliable supplier networks have done so by taking a long-term perspective. Suppliers are routinely assessed and hands-on support provided to develop their capabilities particularly in their quality and CAPA processes. This joint investment binds the companies together with a shared objective and motivation for continuous improvement however it does require selection criteria which addresses both tactical imperatives and broader strategic needs.

5. The healthcare business environment requires dynamic modelling

Healthcare companies typically have a complex business unit structure, manufacturing an extraordinary wide range of products, and selling into multiple worldwide distribution channels. Developing and testing different transformational strategies in such a complex environment can only be done using dynamic modelling tools well beyond the capabilities of usual static methods.

PA has a sophisticated business and market modelling capability which it has used with consumer product clients to analyse the risks, costs and performance of different complex and dynamic global supply chain scenarios.

The evolution of global healthcare businesses must accelerate to stay ahead

The ability of the big healthcare businesses to continue to generate the historical levels of profitability is under increasing threat. The global competitive landscape and new emerging technologies that will change the nature of how new products are developed will have a radical impact on how these businesses will look in the future.

We believe that the time for incremental change has passed and the big healthcare companies must look to bold strategies, learning from other sectors, to transform their businesses into more diverse structures with greater external networks.

Tom Toth is a Consultant in Healthcare at PA Consulting Group. He can be contacted via email at or visit our Healthcare page.

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