Strategic Outsourcing in the Pharmaceutical Industry

Contents

Summary
Outsourcing in the Pharmaceutical Industry
CROs: A Model for Outsourcing
Key Success Factors
The Leap to Strategic Outsourcing
Managing Outsourcing: Skills for Success
Conclusion

Summary (Back to Top)
Strategic outsourcing is an established strategy in industries such as automotive and information technology, but it is still in its infancy in pharmaceuticals. Through strategic outsourcing, businesses use external resources for non-core activities—many of which were formerly considered integral to an organization—and focusing internal resources on one's core competencies. The case for outsourcing non-core activities is compelling, since it can lead to significant competitive advantages.

Outsourcing in the Pharmaceutical Industry (Back to Top)
The U.S. market for outsourced pharmaceutical manufacturing services is growing at 20% per year. When compared to a growth rate of 40% for outsourced manufacturing throughout U.S. industry, clearly the pharmaceutical sector has been slow to adopt outsourcing. A recent PriceWaterhouse Coopers study revealed that even among companies now outsourcing, management "did not perceive third-party providers as important, or even necessary elements in their strategic plans." This indicates that there is room for pharmaceutical companies to rethink the use of outsourcing.

Success in the pharmaceutical industry is measured by the ability to develop and market new drugs, hence the traditional focus on R&D and marketing. While U.S. pharmaceutical companies have routinely used partnerships to reinforce their core activities, most manufacture their products internally to control production and minimize costly mistakes. Until recently, outsourcing has been limited to peak demand periods or to exploit technologies not available internally. Consequently, contract pharmaceutical manufacturing is still highly fragmented and relatively immature.

CROs: A Model for Outsourcing (Back to Top)
The contract research (CRO) industry originated during the 1960s, largely as a result of more stringent requirements by federal legislators to prove the efficacy and the safety of new drugs. The North American CRO industry received a further boost from Japanese pharmaceutical companies that used North American-based CROs. Today 14% of R&D is oursourced and 21.5% of clinical evaluation is performed by third parties. It's no secret that contract research is growing faster than the pharmaceutical industry as a whole.

Due to limited financial resources, biotechnology and startup pharmaceutical companies have been forced to explore non-traditional methods of developing and manufacturing products. These companies are entering alliances with large multinationals and partnerships with third parties. Industry experts are predicting that big pharma will increasingly follow suit in order to access the new technologies that are rapidly becoming available at small, innovative CROs.

At the same time, all pharmaceutical companies are refocusing their resources around core competencies. Economic value added (EVA) and other tools used to measure value creation, combined with manufacturing sites that generally run at less than 40% capacity, reveal operations that drain resources from core R&D and marketing areas.

Faced with marketplace pressure to develop blockbuster drugs, as well as rising development costs and a slowdown in sales, drug firms must dramatically improve R&D productivity or ensure that every drug is a blockbuster. Failure to do either spells failure. If such companies are to survive in their current form, they must dramatically change the way they manage resources. Strategic outsourcing may be part of the solution—just as it has been for many other industries experiencing similar changes in their operating environment.

Key Success Factors (Back to Top)
Companies that have successfully used outsourcing have a clear understanding of their core competencies—and how they themselves add value. For example, after deciding to focus on its core marketing competency, food sector giant Sara Lee restructured its business, sold its production facilities, and began to outsource all manufacturing. As Sara Lee's Chairman and CEO stated, "This new model means that our focus will shift away from the day-to-day management of manufacturing processes or the gathering of raw materials, and toward higher-return activities such as product development, logistics, sourcing, and marketing."

Companies like Microsoft and Apple subcontract all manufacturing, allowing them to focus on their core competencies of software development and testing. Texas Instruments now outsources product development, using external suppliers to access leading edge technology.

The Leap to Strategic Outsourcing (Back to Top)
As companies increasingly incorporate outsourcing in their business strategies, the nature of outsourcing relationships change. When companies begin focusing on areas of core competency, tactical outsourcing becomes strategic outsourcing, bringing a fundamental shift in thinking within the organization.

Traditionally, the pharmaceutical industry has outsourced on a project-by-project basis. Third parties viewed as ordinary suppliers are employed to manage peaks and valleys in demand. Outsourcing is also commonly used to access capabilities not available internally. When a company decides that contractors can provide expertise or value-added services, they rise to the role of preferred supplier. The relationship loses its transactional nature and both parties view the relationship as ongoing.

When significant value-added is attached to the relationship, the supplier is often viewed as a partner. Cross-functional relationships between the client and service provider are established and often include representation from such diverse areas as quality, finance, account management and technology. Explicit performance criteria are created, measured and reported regularly to support continuous improvement.

The shift to strategic outsourcing only occurs when there is an explicit policy stating what the organization itself will do and what will be entrusted to a third party. In an alliance, the organizations share common goals and objectives. The third party will be rewarded for the client's success through the development of shared risk and reward systems. On a strategic platform, the alliance may imply sole sourcing. In its highest form, outsourcing becomes a core competency for the client organization.

Even at the strategic level, each relationship need not be an alliance. There will always be a need for a variety of relationships to meet the diverse needs of the organization.

Pharmaceutical companies will continue to move from tactical to strategic outsourcing, increasingly seeking partners with whom they can establish value-added relationships. Those service providers offering a broad range of services, a global presence, financial stability, and best-in-class quality will benefit the most from the growth in outsourcing. Recent alliances between multinational pharmaceutical companies and service providers, such as those between the Roche Group and Patheon, and Hoecscht Marion Roussel and Quintiles, signal a shift towards strategic outsourcing. In both these cases, the contractors have purchased the client's operations complete with multi-year agreements for the provision of contract services.

Managing Outsourcing: Skills for Success (Back to Top)
Many pharmaceutical companies manage outsourcing relationships through purchasing agents or scientists familiar with the service to be outsourced. These managers may be unprepared to face the challenges inherent in managing outsourcing relationships. Since they are quite familiar—perhaps too familiar—with the details, they become overly concerned with the tactical aspects of the relationship rather than managing high-level performance objectives. To benefit the most from outsourcing, pharmaceutical companies must manage outsourced projects through senior managers with a broad range of skills and talents.

These individuals must have experience leading an organization through change, as well as managing the initial stage of insecurity that change creates. Ideally, this individual would have good working knowledge of all functional areas and be able to manage all aspects of the alliance, from contract negotiation through performance measurement. Supported by a cross-functional team, this senior manager would have the team building skills to create commitment to the process. Future oriented, proactive in anticipating challenges and decisive when the time comes to make choices, this manager epitomizes the new philosophy of outsourcing and strives to make it a core competency for his or her organization.

Conclusion (Back to Top)
By outsourcing non-core activities, pharmaceutical companies can re-allocate assets to areas that generate the greatest value, typically R&D and marketing. They can minimize capital investment in new compounds and, through third parties, access capabilities and expertise not available internally. The use of external resources can also help advance lower priority projects, thus increasing the number of new compounds in the pipeline. Furthermore, effective outsourcing improves the ability to respond to changes in the market place by allowing capital to move more rapidly from declining markets into emerging ones. Companies that are first to embrace the concept of strategic outsourcing and to leverage it effectively will win a significant competitive advantage. Patheon Inc.Laura Macdougall is director of marketing and communications at <%=company%>, 363 West Erie, Suite 3E, Chicago, IL 60610; phone: 800-454-0404; fax: 312-255-8901 Patheon, Inc., a contract manufacturer based in Mississauga, Ontario. Patheon operates five manufacturing facilities in Canada, one in Italy, and is negotiating with Bristol-Myers Squibb for a 300,000 square foot facility in Buffalo, NY.

For more information: Laura Macdougall, Patheon Inc., 2100 Syntex Court, Mississauga, Ontario L5N 7K9. Tel: 905-821-4001. Fax: 905-812-6705.