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By Marco Ziegler, Ulf Schrader, and Thomas Ebel, McKinsey & Co.
Historically, pharmaceutical companies have had very stable demand, driven by a few patented drugs with stable prevalence. Recently, the status quo has changed and will continue to change even more: The share of patented products is dropping and more offerings are generics or “me-too’s.” Today, market growth is driven by line extensions and niche drugs that result in greater supply chain complexity. In addition, global growth is shifting to emerging markets, where distribution channels are more opaque and demand is highly volatile. Finally, tender business (e.g., flu vaccines) with large orders at short notice is on the rise.
The cost of sticking to the current pharma supply chain model is high, both from a strategic perspective as well as a financial one. Strategically, it is much more important today to be quick in capturing market opportunities that arise (e.g., swine flu) than it is to have a superior drug profile. Financially, we estimate that averagely performing pharma companies could boost EBIT by 25% by adopting flexible supply chain processes—and could do so without major investments. COGS improvements can be achieved through optimized product/plant allocation, reduced shelf life expiry cost, stable production schedules, and contracts that allow supplier changes more easily. In addition, by building a more flexible supply chain, companies can cut inventory by around 40%, launch new products sooner, and have fewer stock-outs.
Many industries, from computers to apparel, have proven the value of supply chain flexibility. Companies in these sectors have increased their efficiency and improved their responsiveness to changing customer needs and shifting market conditions. But drug manufacturers still manage supply chains in terms of months and years, rather than days and hours: It takes an average of about 400 days for a drug to go from raw materials to finished product and, typically, 50-70% of a company’s sourced volume is still under fixed annual volume commitments.
Pharmaceutical manufacturers can change this—while meeting their regulatory and quality commitments—by adopting the principles used in other industries. We have identified five key areas—assets, suppliers, people, process, and strategy—where increased flexibility leads to competitive advantage.
Companies with high asset flexibility can boost asset utilization while meeting service and cost goals, and achieve a higher ROIC than their peers through several means:
Drug companies often fail to obtain the levels of supplier flexibility seen in other industries, such as auto manufacturing. They continue to make minimum-volume commitments, sign fixed annual delivery contracts, and accept long lead times for call-off orders. Building greater flexibility into supplier contracts using the following steps can produce savings throughout the system.
People flexibility is essential both to meet changing demand on the shop floor and also to develop and manage a wide global range of suppliers, factories, logistics hubs and sales organizations:
Driven by the fundamental need to minimize inventory risk and avoid losing orders to competitors, companies in consumer electronics and other fast-moving fields have continuously refined their supply chains. Drug manufacturers don’t face the same pressures, but the same end-to-end process improvements apply:
Flexible supply chain approaches should be customized based on the type of product. High-volume drugs with steady demand require a stable, cost-optimized replenishment process. SKUs with variable or seasonal demand, such as vaccines, need faster reaction times. To accommodate these differences, companies may need three or four supply chain variations:
Pharmaceutical companies have focused primarily on reducing manufacturing costs and inventory levels over the last 3-5 years. Going forward, this will be less and less differentiating. But supply chain can be a true differentiator, impacting top-line as well as bottom-line performance. Industry leaders will go beyond the focus on manufacturing cost to adopt a supply mindset and measure total cost of supply rather than COGS. Building flexibility into multiple facets of the supply chain will be critical to maintaining competitive advantage.
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