Gregg Brandyberry is senior vice-president of FedBid, and formerly senior advisor for A.T. Kearney Procurement and Analytic Solutions, Gregg.Brandyberry@FedBid.com

Gregg Brandyberry

For several years, Big Pharma has been cutting programs and reducing headcount as a result of mergers and acquisitions and overall cost-cutting efforts. According to industry estimates, approximately 50,000 pharmaceutical industry employees lost their jobs in 2010, and 300,000 have been let go in the past 10 years (1). Many reasons are behind these cuts: a decline in traditional research and development productivity, tougher regulatory hurdles, a plethora of government and formulary pricing controls, and significant patent expiry of major blockbuster drugs. 

Now, more than two years after the economic meltdown, the industry understands that prosperity is not around the corner. What many call the "New Normal," characterized by slower growth, tighter credit markets, a more conservative approach, less money available for investment, and tighter financial regulations, has become the new operating reality. 

It doesn't have to be all doom and gloom, however. Even in the best-run organizations, there is an untapped source of cash from what I like to call "creating your own stimulus by buying items and services better." In many companies, the cost of purchased items and services (i.e., the money paid to suppliers) is equal to between 30–70% of total company revenue. In the pharmaceutical industry, this cost is typically between 30 and 50%. What I've come to understand is that regardless of how good or how bad a company is at buying products and services, there is still plenty of cash to extract from its costs. Three methods—spend segmentation, better specifications, and online reverse marketplaces—can improve results. 

. By not applying the appropriate sourcing strategy, a company may pay between 10% and as high as 70% more for products and services, based on my experience. This differential exists because of the strategy or lack of strategy that is in place for a certain purchase. Figure 1 identifies four types of supplier relationships by such attributes as ease of buying, supply-market competitiveness, uniqueness, and strategic importance. A buyer's strategy needs to be in the right quadrant to ensure that a company is paying the right price, producing the right total cost, and getting the best value associated with a particular product or service.  

Figure 1: Spend segmentation categories based on customerâsupplier relationships. (FIGURE 1 IS COURTESY OF THE AUTHOR)			

For example, if a company is making a purchase where the supplier maintains the power in the relationship (i.e., the "critical" quadrant), the buyer is paying an absolute premium. Typically, less than 10% of a company's spend will be designated as "critical," according to my experience. Companies with poor purchasing practices, however, often allow suppliers to act as if they were a natural monopoly. A purchaser should review its spending to move supplier relationships from the "critical" quadrant to "strategic" or better yet to "leverage" positions (see Figure 1). My experience suggests that on average, only 20% of spend is truly "strategic," and most of what is purchased can be highly leveraged among multiple suppliers.  

. Many factors determine how much to pay for a good or service. In simple terms, supply is what is available, and demand is how much is being requested. Consumption is how much is being used at what rate, and specification is what constitutes a product or service. The interactions of these variables are the main drivers of price paid.   

Once spending is properly segmented  per Figure 1, four focal points determine  the price paid. A company's strategy affects its ability to pay less, to use less, to use something else, or not to use at all. Take a close look at specifications and carefully review the requirements. In many cases, a company will find individual requirements that are "over spec'd" or not needed at all, which lead to significant and unnecessary costs. Additionally, consumption can often be reduced by making the user community aware of the total costs involved and by policies that control overall usage, particularly for indirect items and services.   

. Think about how a company buys. It is probably one of the following scenarios. The simplest is calling the supplier and accepting the price being quoted. Then there is the "haggle" method, same as the first method, but with some pressure applied to get a lower price. Then more sophistication with the "competitive bid policy," in which the buyer typically gets three bids before making a selection. Another method is to do additional negotiation after getting the three bids, an interesting approach, but it still may fall short in securing the best possible terms.   

A reverse auction, a transparent and dynamic bidding model, is different. All sellers are bidding on the exact same item or service. When using this method, the buyer must have good specifications or requirement documents available to all sellers as opposed to the haphazard way requirements are given using some of the other traditional methods. Because the buying event has great transparency, sellers can see if their pricing leads or lags. The buyer does not have to select the lowest bidder and may weigh other factors in the purchasing decision. Reverse auctions drive pricing to what the market will bear at any given time against various seller independent variables.  

Until recently, the technology required to conduct reverse auctions was costly, required considerable employee training, and presented certain internal and some external barriers for implementation. These barriers, however, are eroding. The premier reverse auction marketplace, FedBid, used by the federal government for 10 years, is now available for commercial use and offers a procurement model for commodity products and basic services. The marketplace has over 50,000 qualified suppliers. More than 50,000 "buys" were conducted in 2010 with savings ranging between 5 and greater than 50%. There is no cost to the buyer for using the technology,  which is web-browser-based. The winning seller pays a modest 3% transaction fee and is billed by the marketplace operator 60 days after the buying award is made. If the product is not currently in the marketplace, the marketplace operator will at, no charge, find the right sellers and even train a company's existing suppliers so they can compete on a regular basis in the marketplace. Reverse auctions can be good for buyers and sellers. Buyers save money, and sellers gain more opportunities to win business. Reserve auctions, along with the other sourcing practices discussed, are potential drivers for value creation.   

is CEO of Wildfire Commerce, and senior advisor for A.T. Kearney Procurement and Analytic Solution

1. E. Teichert, "Top 10 Pharma Layoffs for 2010,"

Articles

Better strategies and practices in sourcing and procurement can contribute to the bottom line.

Offsetting Budget Cuts

I had dinner recently with an old and very insightful Big Pharma colleague of mine and after speaking together, he revealed an important concern. "Gregg, I'm worried," he said. "I think the complexities of our current global supply chain outweigh our capability to control the network," he continued. He was talking about his company's third-party external supply network.  

It's a scary thought, the idea of being too big and complex to adequately control an organization's supply chain properly. But as my colleague and I discussed this in more detail, I definitely understood why he felt that way. For the past 20 years and especially the past decade, the industry has watched the evolution into "gigantic pharmaceutical drug-makers," such as Johnson & Johnson, Pfizer, Roche, Merck & Co, Novartis GlaxoSmithKline, and sanofi-aventis, all $40-billion-plus annual revenue behemoths. 

These global giants are the results of mergers, acquisitions, and myriad comarketing, in-licensing, and other growth strategies to make up for the disappointing failures of traditional research and development. The resulting manufacturing "mash-ups" have created third-party external supply networks that are difficult to manage because of the overall number of contract manufacturing organization (CMOs) involved, long-term contracts (some with substandard organizations), contracts with no provisions for ongoing cost reductions and a host of other nuances that result in the buying organization having a higher risk profile than desired.   

Now, there is no doubt that making changes to the network can be difficult and expensive due to product registrations and other regulatory hurdles on a country-by-country basis. But if a company is willing to play a longer game, with a forward vision, it is possible for it to optimize its third-party external network to reduce all types of supply risk and ensure the ability to manufacture products cost effectively. 

There is a new methodology, called collaborative optimization, which I've had the chance to become familiar with through my work as senior advisor for A.T. Kearney Procurement and Analytic Solutions. The methodology has its roots in optimizing transportation logistics. It's been successfully used in many direct and indirect categories of spend as diverse as packaging, chemicals and temporary labor and also to simultaneously optimize multiple categories of spend used in sequential manufacturing processes. It was designed for complex categories of spend when the complexity comes from many specifications, many potential suppliers with a multitude of capabilities, and regional or global manufacturing and distribution needs.  

Collaborative optimization has three important components. First, it is establishes deep analytics in the cost makeup of a product or service through the creation of an extremely detailed cost breakdown. Second, it gives all suppliers the ability to quote in multiple ways, including creatively (i.e., quote on parts of the business that plays to an individual suppliers strengths and/or provide new ways to meet the requirements that are more cost efficient). This function is called expressive bidding and makes ups the "guts" of a very new type of request for quotation that has an abundance of cost-rich information and cost-reduction ideas.  

The real differentiator with collaborative optimization is the ability to use combinatorial optimization through an embedded combinatorial analyzer that allows for scenario comparisons to be rapidly generated. These comparisons  determine the most desirable outcome based on what a corporation must have. This requirement might be the lowest total price or the best total cost when certain constraints are added. This method overcomes many of the limitations in today's procurement approaches by fostering creativity into the quotation process and handling large amounts of data in a fast and efficient way, thereby enabling the buying entity to determine the best solution for its specific needs. What I like the best about collaborative optimization is that it does not pit supplier against supplier the way traditional procurement practice often does. Instead, it identifies the best way forward that is beneficial to buyers and suppliers alike.    

So, how could this methodology be applied to a third-party external network? To start, a corporation would need to decide it wants to fix the "mess" (a word used by the late, great systems thinker, Russell L. Ackoff, PhD, to describe most current state situations). The company also would need to recognize that the fix might take 5 to 10 years to fully implement.  For a corporation that was willing to play the long game using collaborative optimization, the benefits would be substantial. One benefit is that it allows a company to identify where new contract-manufacturing opportunities should be sourced. It also allows a company to understand where existing contract manufacturing should be sourced and if there is a financial or risk-based business case to support working through regulatory and/or contractual barriers. This method also ensures that the best CMO network had been identified to  reduce all types of risk and provide real cost competitiveness.   

When a company thinks about its the third-party external supply network, a crucial question to consider is whether the company is using a CMO's total capabilities across its total product requirements on a global basis. From my experience, which includes more than 30 years in procurement, the supply chain, and related operations, including 10 years as vice-president of procurement of global systems and operations at GlaxoSmithKline, I'm fairly confident that the answer would be "no." And that reply is really no fault of an individual or an organization. It goes back to what my colleague and I were discussing: the complexities of what an organization is dealing with are greater than its ability to control unless there is a commitment to develop a long-term vision and a willingness to adapt and use different approaches in managing a third-party external supply network. Collaborative optimization offers the potential for annual incremental savings and potentially a lower overall risk profile. 

The key factor for effective supplier management is that once a company has established what its end-state third-party external network should look like and what suppliers should constitute that network, it is imperative that there is an ongoing collaborative environment and culture in place that ensures that future supply partners are always incented to improve and innovate. This evaluation may make an organization take a hard look at the skills or lack of skills that it has in place to support third-party external manufacturing relationships. My guess is that there are some gaps in relationship management. Identifying and filling those gaps is a first crucial step in improving supplier management. 

To gain additional insight from Gregg Brandyberry and other experts, view an educational webcast, "How to Optimize CMC Development and Manufacturing," at the multimedia section at 

The complexity of third-party external supply networks requires new ways to manage them.

A Hard Look at Third-Party External Supply Networks

When I began my career in manufacturing some 35 years ago, I don't remember much talk about supply-chain risk. Yes, we worried that supply could be disrupted, but quite frankly we dealt with those issues as they occurred. Although we strived for "just-in-time" inventories, we generally maintained "just- in-case" inventories and could easily withstand most outages. Most supply chains were regional, and we worried about potential labor-union work stoppages or a delivery truck breaking down 

. Although this description is somewhat oversimplified, supply-chain risk was not as complex or potentially damaging as it is today. 

Besides supply disruption, which has evolved to include risks associated with material scarcity, natural disasters, political instability, and financial collapse, today's corporations must deal with additional significant risks exacerbated by the rapid global transparency of information affecting corporate reputation and even brand image. In this year, alone, we have  seen the disruptive impact of a major earthquake in China, the Icelandic volcano, the Times Square bomb scares, and the Gulf Coast oil spill. The financial effects on supply chains from these incidents is already tens of billions of dollars and will surely be much higher before full resolution and a return to normal operating conditions are achieved. 

The importance of mitigating risk and preserving corporate reputation is underscored by a 2007 study conducted by the global public-relations firm Weber Shandwick in conjunction with the opinion research firm KRC Research, which surveyed 950 business executives worldwide to evaluate reputation risk. The survey found that 63% of a company's market value is attributed to reputation. Nearly nine out of 10 survey respondents concurred that there has been a growing trend of corporate reputation risk. The report cited a 2005 study by the Economic Intelligence Unit, the research arm of 

, which showed that reputation risk is nearly three times greater than the risks from terrorism and natural disasters and surpasses regulatory, human-capital, information-technology, and market risks. Weber Shandwick's corresponding research showed that global media coverage of reputation risk has grown from being practically nonexistent in 1990 to almost daily mentions in 2007.  

Reputational risk is at an all-time high and evident by several recent examples such as recent problems with corporate giants Toyota (i.e., automotive recalls) and British Petroleum (i.e., Gulf Coast oil spill). The question for all responsible executives is: "What is our preparedness to avert preventable risks or respond rapidly to minimize damage should an unpredictable event occur?" 

Despite the importance of mitigating risk, companies may not be sufficiently prepared. Successful risk mitigation in today's complex environment takes a combination of policy, standard processes, technology, strong leadership, and analytical research. 

Five important trends in risk-management preparedness

A comprehensive supply-chain risk-management strategy must involve five key principles: cash-flow management, a balance of low-cost versus low-risk sourcing, strategic-procurement initiatives, incorporation of sustainability practices, and responsible spending. These elements are further detailed below.  

				 With the changing environment of increased regulation, price controls, generic-drug competition, and longer and more expensive research and development cycles, pharmaceutical and biotechnology companies have become much more focused on supply-chain cash-flow management strategies (following the lead of other industries that began implementing these strategies as many as 25 years ago). These strategies consist of a combination of programs that strive to better balance cash inflows versus cash outflows. The supply chain contributes to cash-flow improvement initiatives by reducing inventory and extending payment terms to suppliers. Both strategies, when improperly applied, can and have created increased risk and significant financial consequences that far exceeded the gains. I know of at least one major corporation that mandated 60-day payment terms (from 30 days) when the credit markets were collapsing. This approach seemed almost reckless when considering that for every one million dollars spent with a supplier, a 30-day payment extension only results in a one-time working-capital improvement of $6667 in capital costs (derived from a theoretical savings of 8% × $1 million × 1/12 = $6667). This amount is a very small gain if it also contributes to the financial demise and subsequent closure of a key supplier.  

There is much validity to the idea that the faster cash flows through a supply chain, the less cash is needed to sustain the financial viability of that supply chain. More and more, leading companies are thinking that way. Large corporations such as Syngenta (Basel), Bank of Scotland (Edinburgh), and GlaxoSmithKline (London) are adopting supply-chain financing programs and putting into place technology enablers that allow suppliers to decide when they want to be paid, and of course, at what discount.  

Better balance of low cost versus low risk.

				 Global supply chains have been under development across many industries for the past several decades. Low-cost country sourcing has been on a steady rise for the past 15 years, with corporations leveraging low-cost labor pools for the procurement of goods and services. Most large corporations today have well-defined programs in India and China. As these markets have matured, companies are now sourcing from new low-cost sources located in Eastern Europe and other Asian countries. In general, outsourcing can be risky as evidenced by the issues that Boeing went through with the production of its Dreamliner airplane production, which included major delays, postponed revenue, and lost orders. Massive problems with component deliveries in 2007 led to a two-year delay in aircraft launch and some $2 billion in charges to fix supplier problems (1).  

Outsourcing, combined with low-cost country sourcing, is even riskier. The US Food and Drug Administration's recall of heparin in 2008 due to contamination of lots produced in China is another example. In this heparin recall, the drug was oversulfated as Chinese heparin manufacturers were unethically cutting the medication with chondroitin sulfate to cut down on manufacturing costs. This incident had devastating impacts on those who had chosen to use this Chinese supplier. FDA reported that there were hundreds of serious adverse reactions and scores of deaths among patients that had taken the heparin (2). 

The hard lessons learned from this incident have made it important for companies to reevaluate their low-cost country sourcing strategies. They are evaluating risk versus cost and rebalancing their supply strategies to less riskier profiles.  

Comprehensive strategic-procurement initiatives.

				 One can make a strong case that many supply-chain disruptions and corporate reputation/brand image disasters are preventable, even in the case of natural disasters or other seemingly unpredictable 

-type events. A corporation's procurement organization has the ability to significantly reduce the risk associated with these occurrences by conducting collaborative strategic-sourcing initiatives that ensure their companies are protected from myriad potential risks. Strategic sourcing is a pragmatic and structured procurement process. This process is conducted over several steps and includes: rigorous internal and external analysis; development of multiple strategic options weighted for risk and cost; strategy selection made collaboratively with business stakeholders; well-orchestrated negotiation; and detailed implementation planning, supplier selection, and ongoing supplier management, including continuous-improvement activities. 

Best-practice organizations also use technology to develop solutions to enable the creation, storage, and management of hundreds, if not thousands of risk-management action plans associated with all critical purchased goods and services (see sidebar, "Implementing a risk-mitigation action plan"). 

  Implementing a risk-mitigation action plan			

 As supply complexity and associated risk continues to increase, more companies are recognizing the need to improve their procurement organizations and are engaging third-party assistance to upgrade their strategic sourcing and technology capabilities.  

				 As corporate-reputation and brand-image disasters become more frequent, there are other issues that companies with global supply chains need to address. These broad concerns involve human rights (e.g., child labor, working conditions, unfair pay), global warming, and other environmental impacts. The pharmaceutical and biotechnology industries are also feeling the effects of animal-rights groups that want to ensure the ethical treatment of animals. Nongovernmental organizations (NGOs) play a role in influencing customers, shareholders, and investors. As with most ideologies designed to promote social change, adoption rates by corporations can be classified into three main groups: laggards, followers, and leaders, with the majority of companies acting as followers. 

When it comes to embracing sustainability and green behavior in manufacturing and product specifications, several large corporations such as GlaxoSmithKline (London), Proctor & Gamble (Cincinnati), Diageo (London), and Unilever (London) achieved material cost savings, enhanced brand image, and generated increased demand for their products through innovative changes in primary and secondary packaging components. Examples include reducing corrugated box and cardboard carton-wall gauge, buying board and paper-based components from certified forests, using recycled board and paper, reducing wall thickness of polyethylene containers, and switching to up to 100% recycled polyethylene. These types of changes can reduce the amount of material used, increase the amount of material being recycled, and reduce the overall associated carbon footprint. There is a positive relationship between sustainability and green behavior in enhancing brand image and generating greater sales revenue as a result (3). 

Diagnostic test for supply-chain risk mitigation			

				 The economic meltdown of 2009, the resulting attempts of government bailouts, the many government stimulus programs, and the healthcare overhaul serve to show how the changing environment led to closer examination of corporate spending and has placed an increased emphasis on responsible spending policies and practices. As sales have slumped, more companies have taken a serious look at how to buy goods and services in a way that reduces spending.  

An example from outside the pharmaceutical and biotechnology industries is the luxury expenditure policy, which is imposed on companies receiving funding under the Troubled Asset Relief Program, commonly referred to as TARP or RCP, the federal program under which the US government purchased assets and equity from financial institutions to strengthen the financial sector. The guidelines set limits for entertainment or events, office and facility renovations, aviation or other transportation services, and other similar items, activities, or events. The pharmaceutical and biotechnology industries should take note. A similar scenario is conceivable as the government may take more responsibility for healthcare, and closer scrutiny will be paid to how discretionary budgets are spent. As a result, corporations are reevaluating policies and practices that govern how their goods and services are purchased.  

A simple diagnostic test can assess whether a company is adequately prepared for supply-chain disruptions or mitigating reputational risk. Key questions to consider are: 					

Does a company have a comprehensive supply-chain risk-management program in place?

Does the supply-chain risk-management program have well-documented policies and procedures in place that adequately protect the company against the types of issues that are generating enormous news today (e.g., supply-chain disruptions such as geopolitical instability, natural disasters, financial collapse, inconsistent quality, contamination, and counterfeiting; corporate responsibility such as human rights violations and environmental concerns; and employee responsibility such as fraudulent activities, discrimination, and harassment)?  

Are employees trained and certified in their understanding of these policies on an annual basis?

Is there a systematic process and data-management repository in place to ensure rapid and proactive response to unexpected events? 

Are corporate responsibility and supply-chain risk-management a top priority among the company's senior executives?

The answers to these questions provide insight into whether a company is adequately prepared to mitigate risk in its supply-chain activities.  

 is a partner of Wildfire Commerce, senior advisor of AT Kearney procurement and analytic solutions, and former vice-president of procurement, global systems, and operations for GlaxoSmithKline, 629 Overhill Road, Ardmore, PA 19003, tel. 215.327.5739, 

www.fda.gov/Drugs/DrugSafety/PostmarketDrugSafetyInformationforPatientsandProviders/ucm112597.htm

www.global100.org/annual-reviews/2010-global-100-list.html

The author describes the importance of risk management and offers strategies for risk-management preparedness in supply chains.