Targeting inventories
The big concern for CMOs is the focus on inventory levels. Major companies are trying to turn their inventories more quickly,
i.e., reduce the amount of inventory they carry relative to sales volume. Back when good cash management wasn't such a big
concern, major companies would carry inventory equivalent to as much as 6-months' of product sales. Things have improved somewhat
since then, but many companies still carry more than 4months' worth of sales in inventories, despite working all year to reduce
that. Consumer products powerhouse Procter and Gamble, by contrast, only carries 2-months' worth of inventory in its warehouses.
There was a time when companies could unload inventories by selling products at a significant discount to drug wholesalers
such as Cardinal Health and AmerisourceBergen. After some companies ran into legal troubles for this practice, however, many
switched to paying wholesalers a fee for their distribution services, which forces bio/pharma companies to carry the entire
inventory on their own balance sheets. With the wholesalers out of the picture, companies' principal tactics to reduce inventories
are to cut back on purchases from suppliers and curtail their own manufacturing activities. This is wreaking havoc on CMOs,
which are experiencing delayed and cancelled orders, and smaller orders to an unprecedented extent.
The problem has been noted by a number of CMOs during the past year, but the issue came into dramatic relief at the end of
October 2009 when Lonza (Switzerland) warned of a substantial shortfall in expected revenues and earnings in a company press
statement; the warning was brought about by a cascade of order cancellations and delays that started in late September and
continued through October in both Lonza's biopharmaceutical and small molecule API businesses. Lonza CEO Stefan Borgas blamed
the cancellations largely on working capital management efforts by customers and the reduced volumes forced Lonza to reduce
its projected yearend profits (as measured by earnings before interest and taxes) by more than CHF 200 million (€132 million).
In its press statement, Lonza explained that: "This environment of high volatility is expected to continue for the next few
years." As a result, the company launched an aggressive programme to counter the negative developments, including reductions
in operating costs that it said would save CHF 60–80 million (€40–53 million) in 2 years and cutbacks in capital expenditures
of more than CHF 100 million (€66 million) annually.
Silver lining?
CMOs are likely to face other challenges from these efforts to manage working capital, including having to wait longer to
get their invoices paid. However, the potential impact of the inventory reduction drive is potentially catastrophic. As Figure 1 indicates, the major bio/pharma companies would have to reduce their inventories by another 50% to match the efficiency of
Procter and Gamble.
We doubt that things will get quite that bad for CMOs; at most major bio/pharmaceutical companies, more product is produced
in-house than at CMOs, so the inhouse manufacturing operations should absorb more of the impact, along with raw materials
suppliers. However, as the Lonza announcement demonstrates, the transition period is likely to be painful for CMOs.
In fact, the focus on working capital may create opportunities for some of the most capable and savvy CMOs. Inventory control
efforts include initiatives to produce to demand rather than producing to inventory. CMOs that can demonstrate the flexibility
to respond to short-term ebbs and flows in product demand, rather than insisting on the traditional 90day lock in of orders,
will prove themselves capable partners, which may lead to even more business opportunities. Should companies decide to close
facilities as part of their ongoing restructuring efforts, those CMOs that can deliver product on short notice are likely
to benefit.
Some of the best opportunities in business shaving occur as a result of extreme adversity. The inventory challenge is likely
to be such an opportunity for CMOs.
Jim Miller is President of PharmSource and a member of Pharmaceutical Technology Europe's Editorial Advisory Board.
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