The Effect Of The Financial Crisis On Outsourcing

September 1, 2010
Jagdish Dalal
Pharmaceutical Technology Europe
Volume 22, Issue 9

The economic crisis has affected outsourcing providers in several ways.

The full version of this outsourcing feature can be read in the September issue of our digital magazine: http://www.pharmtech.com/ptedigital0910

The economic crisis has affected outsourcing providers in several ways. First of all, as with all corporations, they are seeing their market value declining and access to capital is also becoming more difficult. As outsourcing providers are typically high capital consumers (since their income trails expenses), many of them are having to manage their expenses more carefully. This tight management usually leads to decisions, such as not fully staffing projects, restricting discretionary expenses, that adversely impact client satisfaction and client acquisition activities.

Jagdish Dalal

On the other hand, the tight economy and companies' desire to reduce operating expenses has led to a higher level of outsourcing activities. However, these outsourcing deals are shorter in contract length (since companies are not confident in their ability to predict the future of their business) and often demand higher value from the service providers. Because outsourcing is a very low margin business compared with most other industries, this has created a tremendous pressure on providers to further reduce their own costs.

Although large established offshore IT and IT-enabled services have done well in capturing a high market share, smaller and more niche offshore service providers are finding that business is slowing because of some of the restrictions being placed on companies who have received government economic stimulus funding. This is quite prevalent in the US and, to some extent, in some EEC countries. Outsourcing providers also face increasing competition from India and China, which are experiencing high economic growth. Combined, all these factors are pressurising other providers into offering economically viable value propositions.

Economic uncertainty and, to some extent, depressed market valuation of service companies, is leading to an increased number of industry mergers. As well as the high-profile acquisitions that have taken place in the pharma market, several large acquisitions have taken place in the IT industry in the last 12 months, such as HP acquiring EDS, Xerox acquiring ACS, and Dell acquiring Perot Systems. This consolidation of service providers and, more importantly, widening of the platform of offering, will change the landscape in coming years. For example, Xerox's acquisition may lead the company to create a document management and data processing product offering aimed at pharmaceutical companies. Meanwhile, Dell–Perot as well as HP–EDS may be able to offer a packaged solution of hardware, software and services in the healthcare industry.

The pharma industry's situation

Public information shows that, as a whole, the pharma industry seems to be following general industry trends of cost management and a higher level of outsourcing activities. At the same time, there is greater pressure on the pharma industry to compete effectively against generic drugs and patent expiries, which has led to stronger emphasis on effectively managing the research supply chain and outsourcing (or partnering) more activities. In particular, there has been an increase in the use of offshore outsourcing for drug testing because of the access to a larger patient base.

For many outsourcing activities, including pharmaceuticals, India and China are considered as destinations of choice. However, the strengthening of the economies in these countries, as well as rising costs of employee acquisition and retention, has led many companies to look for alternative outsourcing destinations, such as South America and Asia, as well as closer to home. For the pharma industry, Costa Rica is becoming an important destination, with Allergan, Eli Lilly, GlaxoSmithKline and Pfizer all using Costa Ricabased service providers, as well as having their own captive operations in this area. Eastern European countries are also becoming attractive locations and as EU membership expands to include many of these countries, it will make them even more attractive to both European and US companies. However, some more remote destinations, such as the Balkan countries, may not be considered for outsourcing because of privacy regulations and confidentiality concerns.

In the coming decade, I believe that many pharma companies will also explore opportunities for outsourcing in Central and South America, as well as in South Africa. These countries offer a growing educated workforce and an increasing market for pharmaceutical products. Consistency and availability of infrastructure, established educational programmes and government encouragement will be key factors in these countries becoming top outsourcing destinations in the future.

Challenges and opportunities

The prevailing economic uncertainty will continue to create a challenging business environment for service providers. For some, this may be a source of opportunity to gain business from companies wanting to reduce their costs, but other service providers may find it challenging to maintain sufficient margins as they are pressured into offering lowering prices. Uncertainty in the capital market will impact new investment decisions, such as creating a network or building new services areas, and will be a driving factor for both the providers and customers of the services.

One of the latest technology directions that is being pursued by large service providers, such as IBM, HP and Microsoft, is called "cloud computing". This is a fancy name for the services where multiple companies share the same resource over a network rather than having these resources fully dedicated to each company. Thus, higher performance hardware and software investment can be shared by many users of services. With this growing interest cloud computing, companies will be looking to providers of these services to compete aggressively against traditional service offerings in pricing services and providing performance levels.

Recently, Microsoft formed a large consortium of hardware/software companies offering cloud computing, and more and more midtier and larger companies will be looking to take advantages of the benefits offered by such services. Globally far-flung, distributed pharmaceutical industry companies will find the offerings particularly attractive with the low cost/impact implementation of services. It will allow these distributed companies to have a common application platform running in one place (on the cloud) making implementation, training and support simpler than having to have multiple copies running globally. Popularity and effectiveness of Salesforce.com is a good example of how cloud computing can help distributed sales forces.

Take advantage of technology

In a competitive pharmaceutical world, companies are not only looking to reduce their cost of operation, but are also looking to service providers to reduce cycle times. Ultimately, this may create opportunities for service providers to offer innovative solutions that take advantage of data mining techniques or more automated management processes — I believe that providers who implement such solutions will have an advantage over those depending simply on labour cost savings. However, the use of new data technologies will also lead to greater awareness and concern with the privacy of information, as well as confidentiality of drug activities.

As recently as 29 July 2010, Microsoft, Google and other technology giants have been appealing to the EEC privacy act body to enable the implementation of cloud computing beyond national boundaries, according to a report in the Wall Street Journal. However, service providers would be required to create safe data environments and provide for a higher degree of warrantee in their services for the protection of private information, which would lead to higher operating costs. I also believe that this will lead to a growing importance of governance processes in an outsourced environment; to date, governance has been a rather low priority topic for both service providers and their clients.

Another related topic that will draw higher attention will be making effective use of knowledge management in an outsourced environment. A recent (2010) informal IAOP study showed that a large majority of customers and service providers either do not understand the implication of knowledge management or have not provided adequate framework for managing it. This is and will remain a critical topic for the pharma industry because a lot of its business activities depend on both shared knowledge and a higher utilisation of knowledge for related activities.

Lastly, as the outsourcing industry continues to mature and service providers begin to leverage their investment in people, technology and process know-how, we will see higher-end processes, such as R&D through drug approval and global drug efficacy support, being outsourced more often than they are today. Some have labelled this "Knowledge Process Outsourcing (KPO)". In the pharma industry, this will lead to the increased outsourcing of crucial activities such as governmental approval process management, copyright and patent protection vigilance, and legal research.

Jagdish Dalal is Managing Director of Thought Leadership at the International Association of Outsourcing Professionals (IAOP) and President of JDalal Associates, LLC.