Pharmaceutical companies can evaluate the opportunities of global outsourcing by considering the strategic approaches of other industries and of the pharmaceutical companies already outsourcing outside the United States and Europe.
Pharmaceutical companies are under constant pressure to innovate, comply with a myriad of regulations, and meet the demands of quality standards—all while delivering as much profitability as possible. Challenges are escalating. Investors are accustomed to double-digit growth, which is a goal pharmaceutical companies will be hard-pressed to achieve as patents expire, blockbuster launches decline, and large customers, especially governments, step-up pricing pressures on the industry.
At the same time, compliance with stricter regulatory requirements is lengthening the time to launch a drug into the marketplace. The average number of clinical trials per new drug application has more than doubled in the past 30 years, and the average number of patients participating in clinical trials has increased two and half times during the same period. Research and development (R&D) costs also are rising. In fact, the cost of bringing a new drug to market has more than doubled in the past decade and is approaching US$1 billion (1). The pharmaceutical industry's general and administrative costs are high as well—at 28% of revenue, based on A.T. Kearney's analysis of the top 10 pharmaceutical companies' 10K submissions. Pharmaceutical general and administrative expenses, as a percentage of revenue, were two-thirds higher when compared with a broad mix of companies in highly technical, process industries, consumer goods, and retail mix. There's no quick fix, but pharmaceutical companies must control costs and increase productivity.
It's inevitable that global outsourcing will become a part of the answer as it has in other industries (see Figure 1). Financial institutions, led by GE, Citibank, Amex, and HSBC, are guiding the way. In 1999, Citibank formed e-Serve International Ltd., a business processing company based in India. The company's offerings include transaction, customer care, and technology services. Four years after being established, e-Serve performs more than 100 million transactions per year.
Figure 1: In global outsourcing, pharmaceutical companies are following other industries.
Other industries such as automotive (in Stage 4) and consumer products (in Stage 3) have shown substantial progress in moving along the lifecycle curve. Procter & Gamble, for example, is consolidating its administrative functions into three business service centers in Costa Rica, the United Kingdom, and the Philippines. This initiative is part of Procter & Gamble's Organization 2005 program. These three sites will provide employee services, purchasing, information technology, finance and accounting, and customer logistics. As a combination of traditional outsourcing (i.e., using an external firm rather than internal resources to provide a service) and offshoring (i.e., seeking services outside the country), global outsourcing represents an opportunity to find the most efficient and effective means of bringing drugs to market. Traditional outsourcing is not new to the pharmaceutical industry. Many companies already look outside their own walls for services in information technology, payroll, manufacturing, clinical trials, and clinical trial data management.
Until recently, however, pharmaceutical companies have been reluctant to outsource beyond the United States and Europe, in part because of concerns about intellectual property protection, demands for regulatory compliance, worries about political stability and business continuity. Given the pressures on the industry, however, the potential benefits of global outsourcing are difficult to ignore. Simply put, the industry cannot maintain the status quo. A.T. Kearney analysis indicates that if growth and pricing pressures maintain their current trajectory, by 2008 the US pharmaceutical industry will face a US$48-billion gap between investor expectations and estimated revenue (see sidebar, "Running the numbers").
Running the numbers
Because global outsourcing can help pharmaceutical companies address cost pressures and the need for increased productivity, while also leveraging capacity and capabilities, it is inevitable that the global outsourcing trend will grow. The opportunities for pharmaceutical companies are significant: accelerated time to market and greater profitability. On the other hand, companies that wait to see how others in the industry fare may be forced into playing catch-up.
The benefits: time and money
Why push the outsourcing envelope? Although cost-cutting often is the first reason cited—and certainly a key concern—global outsourcing can yield various benefits. First, time is money, and outsourcing can save time. If companies can shorten today's long lead times for drug development by handing off tasks to third parties that can perform them more quickly because of fewer constraints or additional resources, they will find themselves in an advantageous position. For example, companies conducting clinical trials in India and China can take advantage of a large population base and a diverse pool of currently untreated patients, which are two factors that can accelerate clinical trials.
Global and domestic outsourcing can play a key role in shortening the drug development process by enabling pharmaceutical companies to hand off selected tasks, thereby freeing up resources to devote more time to additional strategic activities. Global outsourcing also can enhance the quality of and access to talent. Many firms are tapping into India's pool of scientists, who have solid capabilities and strong expertise. AstraZeneca, for example, recently built a research facility in Bangalore that focuses on tuberculosis. The company plans to invest another US$30 million during the next five years for laboratory equipment and operations costs. "Our investment here in Bangalore is definitely not based on cost, because the cost of doing research is mainly a small part of the total global research and development efforts," Sir Tom McKillop, AstraZeneca's chief executive, told India-based pharma portal pharmabiz.com. "The only reason for opting for India is the quality of scientists."
Of course, the savings are compelling. The costs of direct and indirect personnel, depreciation costs, and material are roughly 40% lower in countries such as China and India (see Figure 2). Our analysis assumes that indirect staff includes both local offshore and US corporate oversight; local offshore oversight helps lower costs.
One example is clinical trial costs. ClinTec International, a privately owned full-service contract research organization with headquarters in Germany, for example, reports that recruiting 200 patients in the United States for a one-year study would take approximately 3–6 months. ClinTec claims this time can be cut in half by recruiting patients in India. The time required for data analysis also can be significantly shorter, from 6–10 weeks in India versus nearly four months in the United States. According to the company, the estimated cost savings may reach 50–60% compared with the costs of conducting the trials in the United States. Lower costs are a result of lower wages of key personnel involved in conducting clinical trials and data monitoring (e.g., clinical research assistants, project management, clinical data management, and biostatisticians) and lower investigator grants (i.e., payments to physicians for their expertise and time in monitoring clinical-trial patients).
In addition to these savings, companies can avoid significant fixed costs and capital outlays. For instance, by partnering with a local pharmaceutical company for selected drug discovery efforts, companies can minimize capital investment associated with setting up their own R&D facilities in offshore locations. For labor-intensive activities, the low costs of labor and infrastructure abroad are more than enough to offset such added expenses as additional travel and higher telecommunications costs.
Good reasons for reluctance
Despite the opportunities, the news isn't all good. When A.T. Kearney and CFO Research Services conducted interviews with executives and professors from 13 pharmaceutical and biotechnology companies and academic institutions in Q2–Q3 2004, those surveyed expressed many misgivings about turning over complex functions to third parties overseas (2). "Pharmaceutical companies are notoriously conservative on everything they do. They do not like to give up control of anything," notes Andrew Bonfield, chief financial officer of Bristol-Myers Squibb.
Given pharmaceutical company executives' low tolerance for error, this lack of control, even when ceded to qualified personnel, is understandable. Mistakes can lead to regulatory delays, mask a drug's true effects, or potentially even harm patients, thereby opening up pharmaceutical companies to significant liability. Russ Bantham, general counsel and senior vice-president of the Pharmaceutical Research and Manufacturers of America, summarized the importance of data integrity in a comment that is applicable beyond clinical trials: "Misreading, losing, or misentering one piece of data could result in a multibillion-dollar lawsuit."
Intellectual property protection is very high on the list of worries. "Clearly if you go offshore, the ability to protect your proprietary information such as patents is subject to much higher risk," says Maurice Greaver, president of Greaver & Associates, a management consulting firm. Compliance is another big concern. Vendors in emerging markets such as India and Asia have various levels of experience in satisfying rigorous and constantly changing regulations. Add to this the difficulty of managing relationships between pharmaceutical companies and offshore companies from another corner of the world as well as the potential for delays, and the challenges begin to look nearly overwhelming.
Many of the most troublesome issues are beginning to be addressed. New legislation on intellectual property protection in India, for example, brings the country's intellectual property laws in line with those of the international community in accordance with the World Trade Organization. How these new laws will be enforced is under debate, and it will certainly take some time for them to become standard practice.
In China, for example, the intellectual property situation is subject to interpretation. Pfizer's patent problem with Viagra is one high-profile example. The Chinese government revoked the patent in 2004, claiming the company had not adequately shown that Viagra was worthy of patent protection (Pfizer has appealed the ruling). The Chinese government also is enacting laws and regulations to curb the theft of intellectual property, however. During the past two years, Chinese courts handled more than 1700 intellectual property violations, and the government established a work group to address the issue. With the enforcement of intellectual laws a key issue, these moves don't immediately resolve the intellectual property problems, but they are a step in the right direction.
Of course, many risks remain, and it is imperative that pharmaceutical companies develop a detailed plan for avoiding or actively managing them.
A world of possibility
Where to explore global outsourcing options may be a big question companies face. The territory isn't as uncharted as it may seem. Financial institutions, automotive companies, and consumer products companies are further along the offshoring curve. Although the needs of each industry are unique, pharmaceutical companies can learn from the experiences of other firms.
For instance, one-fifth of Fortune 500 companies already have R&D facilities in India. GE has its second-largest R&D facility in Bangalore. With an investment of US$60 million and 1600 researchers, GE plans to add another 800 researchers. In just the past three years, the center has filed for 95 patents.
India is getting the lion's share of attention as an offshore destination and is at the center of the pharmaceutical offshoring activity in emerging markets (see Figure 3). China is beginning to gain a foothold in the pharmaceutical space as well. A cross-industry A.T. Kearney study on foreign direct investment reinforced the attractiveness of China and India at a macro level. These countries took the top two spots in positive investor outlook, likely first-time investments, and most preferred offshore investment locations for business processing functions and information technology services.
Figure 3: Cost structure differential between EuropeanâUS manufacturers and manufacturers in India and China. Key to numerical superscripts: (1) includes cost of goods sold without cost for raw material; (2) assessment of direct personnel cost reduction from approximately 60 to 6 total salary dollars (tsd)/FTE, indirect personnel cost reduction factor of 2; (3) assessment of direct personnel cost reduction from approximately 6 to 3 tsd/FTE (source: A.T. Kearney).
The study, which included a survey of CEOs, CFOs, and other senior executives of the world's largest 1000 firms about their opinions of various investment destinations, revealed that investors look to China and India for different strengths (see Figure 4). India offers vast experience in business process outsourcing, and a large, well-educated labor force. Two million proficient English speakers with strong technical and quantitative skills graduate from Indian schools each year. When it comes to the pharmaceutical industry, India has an impressive and ambitious workforce. On the other hand, investors in various industries prefer China for incentives, costs, and infrastructure. Although China is now perceived as ranking behind India in terms of information technology and English-language skills, the country is working to narrow the gap.
Leading companies in various industries are increasingly following multinational strategies to ensure business continuity. Conducting businesses on new shores opens a company up to a range of new risks such as natural disasters and political instability. Alternative plans and partners help create a buffer against the unexpected.
Because of the complexity and risk associated with offshoring, not all companies realize significant advantages. Still, by looking at how other companies manage outsourcing risks and tap into the opportunities, pharmaceutical companies can draw their own roadmap for success. Companies at the forefront of the outsourcing trend succeed by taking a methodical approach to planning and implementing their outsourcing strategy.
Plan the outsourcing strategy. Organizations typically have good intentions to approach outsourcing in a strategic fashion but end up outsourcing on an ad hoc basis, according to a recent report from CAPS Research, A.T. Kearney, and Arizona State University (3).
Best-practice organizations, on the other hand, begin with a big-picture view of the challenges they are wrestling with and the goals they want to achieve. Cost-cutting is an important consideration but also the easiest one for rivals to copy. Companies should consider whether they need to speed up the development process or gain access to innovative technology.
Leading companies also look explicitly at each activity to decide whether to send it offshore. If the decision is made to offshore the activity, the companies then determine which geographic markets are best suited to the function (see sidebar, "What to move? It depends" for a comparison of pharma companies' current approaches) Of course, the answers to these questions will evolve over time.
What to move? It depends.
It is also important that companies assess the most appropriate business model such as one that reflects the organization's risk and return profile. A captive model established and run by the parent organization offers maximum control, process consistency, and intellectual property protection. But at the same time, companies reduce the savings potential, lay out more capital, and take more time to start up operations when compared with outsourcing. Captive models work best for processes that require more control. Selected examples may include functions such as discovery and bioprocess R&D and clinical development. Each company's specific circumstances, however, will determine whether one particular model is more appropriate than another.
A joint venture model has lower levels of business risk and investment than a captive model. Joint ventures enable companies to retain a great deal of control over processes and to accelerate time to market. Among the drawbacks, though, are the capital investment required, the management and contractual complexities, and the risks of transferring skills to partners. Selected examples of joint ventures could include clinical trials, formulation development, and manufacturing process development.
Contract manufacturing and outsourcing offer significant cost savings, maximum speed to market (which accelerates benefits), increased flexibility, and low capital investment. But there are also risks, including less control of processes and output, the risk of public reaction to job loss, and less protection of intellectual property. Business processes such as information technology, accounts receivables and payables, and payroll are examples of areas in which this approach has been successful. In addition, contract manufacturing is increasingly being considered for outsourcing.
Figure 6: Top pharmaceutical companies R&D and manufacturing offshoring activities and ramp-up plans in India (source: company 10Ks, A.T. Kearney research and analysis).
Regardless of the business model chosen, top global outsourcing companies begin their strategies with a solid fact base rather than a reliance on perceptions. A solid business case should be built, supported by baseline performance metrics, to guide implementation of the outsourcing strategy.
Top outsourcing companies also involve senior management from departments that will be affected by outsourcing strategies such as those in R&D, engineering, manufacturing, and logistics. They contemplate what-if scenarios to determine how these scenarios could affect resources and results.
Finally, top companies make better outsourcing decisions when the choices are integrated with a longer-term vision and plan, instead of making decisions as short-term tactical responses. Focusing on the near-term makes it difficult for suppliers to gauge future demand, which in turn can lead to capacity issues in the future.
Select the right partners. It is always important to apply a rigorous supplier-selection process, especially when evaluating suppliers in emerging markets. By standardizing the process, organizations can save time and incorporate lessons learned from past experiences into future situations.
Figure 7: FDI Confidence Index 2004, China versus India (source: A.T. Kearney Global Business Policy Council survey).
Pharmaceutical companies must have a complete understanding of their strategic reasons for outsourcing each task and of the benefits they want most to gain. For example, if a company values speed to market more than cost savings, then it should weight its supplier evaluations accordingly.
One of the most important factors to consider when outsourcing to a company in an emerging market is the candidate's track record. A supplier that has demonstrated its capabilities working for other large pharmaceutical firms and has a sustainable track record on quality and intellectual property protection is likely to be a more attractive candidate. Reference checking is a normal course of business in any outsourcing arrangement, but when dealing with emerging markets, due diligence is critical.
Leading companies often look for opportunities to bundle services and to strategically partner with a smaller number of suppliers when appropriate. One executive told us, "We are interested in outsourcing to a partner that can perform the entire development through launch." Because such arrangements lead to spending more with each supplier, they help companies negotiate greater cost savings and more favorable contracts.
Structure arrangements carefully. The executives we interviewed believe it is important to structure a contract with pricing that benefits both sides. A win–win deal is better than squeezing maximum concessions from a supplier because it sets the stage for working together constructively. If the contract is priced too low, then there is a danger that the partner will quit or raise prices sharply in the future.
Key decision makers should be involved in the selection of suppliers. Senior management from departments that will be affected by outsourcing strategies such as those in R&D, engineering, manufacturing, and logistics also should play an active role in developing the outsourcing strategy. It is important to consider a range of perspectives given the potential for significant changes in resources and results.
Each outsourced activity and each outsourcing strategy has its own goals and potential complications; therefore, the structure of each contract should reflect those differences. In some instances, a company may want process improvements from a supplier, notes Rudy Hirschheim, a professor at Louisiana State University. Offering incentives that reward service providers for such improvements is the best way to make them happen, he says.
Manage outsourcing performance. Turning an activity over to a third party doesn't mean forgetting about it. "Outsourcing does not mean abandoning. You must manage on a daily basis," says David McGirr, chief financial officer of Cubist Pharmaceuticals.
To receive the full benefits of outsourcing, companies must establish formal roles, procedures, and metrics. Best-practice companies appoint a governance committee to manage the selection and performance of service providers, review and approve the outsourcing strategy, and resolve issues. They create a process for reviewing suppliers on a quarterly basis (or less often for less-strategic relationships). Timelines and frequent communication are important parts of the equation.
In addition, leading companies create scorecards to evaluate supplier performance on both a qualitative and quantitative basis. By clearly setting expectations up front, these tools can minimize delays, cost overruns, and problems related to quality, which are some of the biggest issues pharmaceutical companies face when they outsource. Scorecards should include general metrics that apply to all areas (e.g., adherence to deadlines) as well as measures that are specific to an activity. By formally surveying a cross-section of those who work with the supplier, companies get a more detailed picture of whether trust and communication are at optimal levels.
Sometimes relationships don't work out, despite an organization's best efforts. Companies must prepare for that possibility by establishing procedures up front for resolving issues and for exiting the contract, if necessary.
Making the move
Choosing to move closely held processes to far-flung shores is no easy decision, but the potential benefits are too compelling to ignore. Leading pharmaceutical companies already are following in the footsteps of other businesses, assessing where they could be more competitive, and evaluating where a global outsourcing strategy would further their efforts.
The road isn't easy. Many challenges remain, from intellectual property protection to supplier management to quality concerns. But some companies are learning to manage those challenges to achieve the potential global outsourcing has to offer—those that aren't are in danger of falling behind.
Chris Paddison is a vice-president at A.T. Kearney, Inc., Chris White is a former vice-president and alumni of A.T. Kearney, and Carol Cruickshank is a principal at A.T. Kearney Ltd., Box 68, Suite 2300, 20 Queen Street West, Toronto, ON M5H 3R3 Canada, tel. 416.596.3749, fax 416.977.1315, email@example.com
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1. Parexel's Pharmaceutical R&D Statistical Sourcebook 2004/2005 (Parexel International, Waltham, MA).
2. Outsourcing Among Pharmaceutical and Biotech Firms: The Growing Imperative for a More Aggressive Approach to Outsourcing (CFO Publishing Corp., New York, NY, 2004).
3. Outsourcing Strategically for Sustainable Competitive Advantage, available at www.capsresearch.org.