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Novartis, BMS, and other companies are reducing complexity by thinning out product portfolios. Reducing complexity can reduce waste and improve responsiveness, but it must be done right.
Disclaimer: The views expressed in this article are attributed solely to the author and not to IBM.
The pharmaceutical industry’s move from a blockbuster to a niched business model has resulted in overly complex portfolios, leading to inefficient use of resources and limiting companies’ ability to react quickly to changing market dynamics.
Increasing complexity can be seen, not only at the level of materials, but throughout the enterprise. For pharmaceutical companies, it generally shows up in manufacturing, supply-chain management, information and work flow, and quality functions. Its symptoms are summarized as follows:
Traditional operational excellence approaches (e.g., Lean manufacturing or Six Sigma) can become untenable when the product stream is too complex. As a result, more pharmaceutical companies are examining their portfolios more closely to find ways to reduce complexity, and with it, waste, costs, and inventory levels. This article proposes the use of a comprehensive approach that targets both large and tail-end products for rationalization.
Although complexity reduction (also referred to as stock keeping unit [SKU] rationalization or reduction, or product pooling) is widely used in industries such as consumer products and retail, it is a relatively new concept to the pharmaceutical industry.
When complexity is managed effectively it turns into competitive advantage. Remember to do the following:
Beginning a complexity-reduction program requires focusing on the following specific areas.
Rationalizing redundant products. The first area to focus on in reducing complexity targets medium to large SKUs that do not directly satisfy a unique customer requirement. Removing redundant products offers significant cost savings, particularly for larger products that consume more resources. Secondly, it has no impact on sales levels demand shifts to remaining products that still meet the customers’ requirement.
Removing smaller, less profitable products and product groups. Rationalizing products at the tail-end allows critical resources to be reallocated to more profitable products or new product launches. Some progressive pharma companies such as Novartis have piloted and partially implemented this approach with impressive results. Taking this step promises to improve demand forecast accuracy, production write-offs, asset utilization, and replenishment lead times.
The complexity fingerprint. Creating new products is not always the best way to achieve growth or profit, and often results in large, highly customized product portfolios and higher production, distribution, and other organizational costs. However, not all complexity is bad. When examining portfolios, it is important to distinguish between “value adding” and “value destroying” complexity. Research suggests using a “complexity fingerprint” (1) to identify specific areas of excess complexity.
The complexity fingerprint, shown in Figure 1, is created by identifying the specific complexity drivers of a company-such as existing technologies, brands, products, and customers-and comparing this total number against the segment producing 80% of total earnings before interest and taxes (EBIT).
A large gap, as illustrated by the large yellow area under the Products (SKUs) and customer drivers, between the total number and the segment producing 80% of total EBIT, suggests a need to reduce complexity.
The complexity fingerprintenables transparency, catches management's attention, and leads to focusing and prioritizing problematic areas. For example, a manager in the company with this complexity fingerprint can easily see that packaging is an area of value-adding complexity, because 52% of packaging configurations account for 80% of packaging’s total contribution to overall EBIT. The manager can feel comfortable with the level of complexity in packaging.
However, this manager could examine the company’s customer base more critically, because only 10% of all customers contribute 80% of EBIT. Complexity reduction efforts could therefore focus on managing or pruning companies in the 90% of clients that contribute less than 20% of EBIT.
Ensure that the right areas are targeted. When embarking on complexity reduction programs, there is always a risk of rationalizing in the wrong areas, cutting too deeply into revenue streams, discontinuing key products, or damaging important customer relationships. Companies can avoid this by conducting frequent product reviews with customers.
In addition, it is important not to focus exclusively on removing tail-end SKUs, because this often results in insignificant changes in inventory, gross margins, market share, changeovers, or distribution complexity. Additionally, any cost savings resulting from tail-end product rationalization tends to be short-term because the tail-end of any portfolio always replaces itself over time.
Don’t overdo it. The benefits of successful complexity reduction can be felt across the entire organization. In fact, the consulting firm A.T. Kearney estimates that systematic complexity management can lead to an average EBIT increase of 3–5% percentage points, from improved production and logistics, lower material costs, adjusted service capacities, and increased margins.
However, it is important not to reduce complexity too much within a single brand. Studies using data from an online retailer suggest that brands with higher market shares, higher price levels, and more frequent promotions tend to gain share when effective SKU-reduction processes are in place [reference?]. However, this research also found that a drastic reduction of SKUs within the same brand had negative impacts on brand performance,and that brands with small market share were less likely to experience the benefits of complexity reduction.
Complexity reduction has not been discussed much in life sciences because, historically, the pharmaceutical industry has not focused on reducing costs. Pricing has traditionally depended more on the perceived value and patient base for the pharmaceutical than on its production costs.
However, business conditions in the industry are changing as the use of generics grows and products are commoditized. In addition, development and production capabilities are expanding globally, increasing the level of competition. Operational excellence, including cost reduction initiatives, is getting more attention in the industry.
As stated previously, the most effective way to approach complexity reduction is to focus on redundant product rationalization and tail-end pruning, as shown in Figure 2.
However, it can be difficult to identify the tail end in the pharmaceutical industry. Many niche pharmaceuticals are not good candidates for pruning due to their strategic value or high profitability. As a result, any such pruning should only take place after a core group of small but critical products has been identified that must remain in the portfolio.
In short, complexity reduction is a simple concept that offers benefit, but it can be difficult to implement. One challenge is the fact that its benefits are difficult to quantify and predict, precisely. In addition, there can be significant cultural barriers to efforts that may result in loss of what many employees may consider to be a pet product, customer, or facility.
Overcoming these challenges requires strong and vocal support from senior management and key stakeholders. In addition, the process must be aligned with the organization's strategic goals, the data required must be of high quality and readily available. Finally, a mechanism must be in place for estimating the cost of complexity that goes beyond mere cost of goods sold (COGS).
Before the process can be implemented, a group of influential stakeholders must be gathered.
In addition, complexity reduction efforts must be aligned with the organization’s strategic goals. Additionally, the organization's strategy should include a plan on how to use resources that have been made available after complexity reduction. These resources could be used to meet unmet demand, alleviate over-utilized equipment, or free up resources in preparation for a large new product launch.
At Bristol-Myers Squibb, for example, there is an on-going goal of drastically reducing inventories and a culture committed to cost reduction and process improvement. After communicating how complexity reduction naturally supports these organization-wide goals, key stakeholders were eager to support this initiative. If a company's strategic goals include a commitment to high product variety, this process may not get the necessary support to be successful.
To facilitate an efficient and complete analysis, product, market, and production data must be of high quality and readily available. Some data (e.g., sales volumes and demand forecasts) will be easy to get. Other information, however, will be difficult to gather.
Finally, a method must be agreed upon to estimate the complexity costs of individual products. Complexity costs include COGS, as well as other overhead costs that could be avoided if the product is rationalized from the portfolio. These costs, which include marketing resources, production changeovers, intermediate inventories, testing and quality resources, and regulatory costs, can be significant and need to be included in any SKU-reduction business case.
The pharmaceutical industry has many intricacies that distinguish it from other industries with well-documented SKU-rationalization approaches. These intricacies demand a more thorough analysis of the product portfolio in terms of market usage and production data. Rationalizing redundant products seeks to build an efficient portfolio based on identified customer requirements. If a product does not meet an explicit customer requirement, it should be removed from the portfolio. The tail-end pruning process identifies small, underperforming products that consume resources that could be better used elsewhere. With this process, there is the potential of losing some revenue, but the cost savings, which includes complexity costs, should make up for any loss in revenue. Additionally, the newly available resources should be applied to other products in an effort to grow revenues for lower cost products.
To successfully implement this complexity reduction approach, there must be strong vocal support from key stakeholders, the process must be aligned with the organization's strategic goals, data must be of high quality and readily available, and there must be a mechanism to accurately estimate complexity costs beyond COGS. This comprehensive complexity reduction approach has the potential to greatly reduce costs while making critical resources available for reassignment.
1. S. Scheiter, O. Scheel, and G. Klink, G, "How Much Does Complexity Really Cost?" A.T. Kearney, Dusseldorf, Germany (2007).
Partha S. Anbil is a cognitive enterprise transformation leader (email@example.com) with IBM’s Healthcare and Life Sciences practice.