Supply Chain Yoga

The cost of sticking to the current pharma supply chain model is high, from a strategic and financial perspective. Here are five key areas where increased flexibility leads to competitive advantage.

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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.

Asset Flexibility
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:

  • Flexible scheduling within plants: Dedicate lines to high volume products and keep 20-40% capacity for unpredicted demand. Flexible packaging equipment and a pack-to-order concept enables them to realize small orders on short notice.
  • Balancing capacity: Shift volumes between in-house and external facilities. A monthly S&OP process helps determine opportunities by line, technology or product. Mothballing plants also can help to manage variability.
  • Structural regulatory flexibility: Implement flexible regulatory strategies that enable the shifting of volumes of easily made products to second sources in low-cost regions, which frees up capacity to launch new products.

Supplier Flexibility
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.

  • Strategic sourcing plans: Enlist backup or dual sources for critical products and define supply contingency measures with preferred suppliers.
  • Contracting for flexibility: Add contractual terms for supply flexibility. Products with an unstable production process might require additional safety stock, products with erratic demand profile a very short order lead time.
  • Integration and lean processes: Jointly forecast and set targets with suppliers to improve efficiency. In some cases, suppliers can be fully integrated into plants’ planning and budgeting processes.
  • Supplier development and renewal: Use dedicated resources and processes for new supplier screening, auditing, and development to create a constant stream of options in the supplier base and enable continuous improvement.

People Flexibility
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:

  • Multi-skilling and labor flexibility: Train multi-skilled operators and introduce flexible staffing across departments to keep machines running during breaks, speed up changeovers, and perform maintenance during idle times. Introducing annual time accounts and flexible shift systems, and use more temporary staff to manage ups and downs with existing employees without raising costs. In some cases, especially for cyclical products like vaccines, cross-company sharing of resources is an option.
  • Global innovation task force: Enlist a group of strong, internationally deployable project managers to establish best practices, ensure a fast rollout across local units, and provide ongoing performance monitoring, coaching, and support.

Process Flexibility
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:

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