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Pharmaceuticals Refine Their Sourcing and Operational Strategies

Wed, 11/07/2012 - 6:33am
Jon Lightman, Director, Life Sciences Practice, ISG

As the grim specter of the patent cliff looms ever closer on the horizon, major pharmaceuticals are shedding their longstanding complacency regarding operational performance and launching initiatives aimed at driving significant and sustained efficiency improvements.  Coupled with that imperative, pharmaceuticals must address a range of emerging organizational and regulatory issues to ensure competitiveness over the long term.

For many, efforts are focused on managing IT and business process outsourcing relationships to enhance visibility into operations and optimize the value delivered by service providers. More specifically, pharmaceuticals are employing a variety of techniques to assess and improve operational competitiveness, integrate multiple outsourcers to work together seamlessly, and manage provider relationships on an ongoing basis. Those that succeed will be best-equipped to address the myriad operational challenges confronting the pharmaceutical industry today.

Thanks to the luxury of generous revenue streams from patents, the pharmaceutical industry has long viewed cost reduction as a low priority, and has therefore lagged behind other sectors in driving efficiency. Priorities are changing, of course, and today pharmaceuticals are setting aggressive cost reduction targets and turning to service providers to achieve them.   

In many cases these targets are being set arbitrarily, without regard to the performance level or strategic role of individual operational towers or business units.  While intended to “trim the fat” in operations, enterprise-wide, across-the-board mandates to reduce spending by a certain set percentage risk sacrificing future efficiencies for short-term gain by cutting essential capabilities and hampering innovation and responsiveness.

Defining Operational Baselines

Benchmarking of IT and business operations can help address this challenge by allowing pharmaceutical firms to assess their environments – either outsourced or internally managed – and achieve significant improvement without crippling essential capabilities.  Since, from an operational standpoint, many pharmaceuticals are either underperforming or don’t have a clear sense of how they are performing, a benchmark can provide an essential baseline from which a forward-looking change plan can be built.

Put simply, benchmarking shows an organization how it’s doing relative to industry peers as well as top-performing organizations with similar characteristics. The process involves data collection (quantitative and qualitative) around a hierarchy of metrics that represent the operation assessed. That data is then analyzed in a comparative context to identify performance gaps and point the way towards actions that drive improvements. 

An effective benchmark analysis:

• Provides a transparent baseline of current performance.

Analyzes current performance against that of world-class organizations, industry peers, non-peers of similar scope and size, or the organization’s own performance over time.

Quantifies the gap between existing and optimal performance, thereby defining the scope of the potential opportunity in terms of cost savings, headcount re-allocation, or improved cycle times, quality, or productivity.

Identifies the root causes of performance gaps at a granular level, enabling analysis that leads to an action plan to enhance efficiency in the operation or process.

Benchmarking analyses can be applied to sourcing decisions in a variety of ways. At a high level, a benchmark provides a contextual understanding to justify a particular course of action. For example, if a benchmark shows that a provider’s pricing and service quality meet competitive standards, a client can build a business case to renew an agreement with the incumbent.  And if the analysis reveals a significant gap between the provider’s services and the market, then a decision to re-bid and pursue a new agreement is similarly justified. 

For an internally managed operation, meanwhile, a benchmark gauges how the internal operation stacks up against the market and allows management to determine if outsourcing is warranted and, if so, where improvement opportunities can be most readily found.

At a more detailed level, a benchmark can be used to formulate and define specific actions that drive improvements in operations. While a high-level benchmark might show that an organization’s overall costs are more or less in-line with market conditions, a “drill-down” analysis focuses on individual towers and functions, and reveals the anomalies within those towers that are at the root of performance gaps. This diagnostic element, meanwhile, enables corrective action.

Benchmarking can be a particularly effective way to conduct a reality check of a cost reduction mandate.  If a goal is set for an enterprise-wide cost reduction of 20 percent, a benchmark analysis might reveal that a 15 percent reduction is the optimal solution – or, indeed, that a 25 percent reduction is feasible. More importantly, a benchmark can – over the course of a few weeks – distinguish between high-performing service towers and those with significant room for improvement, allowing the latter to be targeted to deliver a disproportionate share of the savings.

Benchmarking can also identify low-hanging fruit and quick-win opportunities that will show immediate savings, thereby building momentum as well as a budget to support subsequent action.  IT Storage represents one area where savings are often found.  In this service tower, ISG has seen annual unit price decreases of 25 percent to 30 percent for hardware, 30 percent to 35 percent for services, and 5 percent to 10 percent for software.  The problem is, pricing structures often fail to keep pace with these rapidly declining unit costs. As a result, the actual prices paid for storage hardware, software, and services are often considerably above market levels.  Add to this the fact that ill-defined or badly implemented data retention policies often mean that data is kept significantly longer than needed to meet legal or regulatory requirements, and you compound the problem.

By identifying and quantifying these gaps, clients can revisit purchasing agreements or outsourcing contracts to ensure that pricing aligns more closely to market trends. Given the significant challenges pharmaceuticals face around data storage, a renegotiation of storage pricing can be tied to a discussion around a comprehensive storage and data management solution, thereby providing the outsourcer with an incentive to restructure the deal. For example, an investment in asset mapping may release additional benefits by reducing unconstrained demand for storage resources.

Telecom services is another potential quick win opportunity.  Service providers today are willing to adjust contracts to reduce rates in exchange for extended contract terms. By providing detailed knowledge of existing rates in the context of competitive market standards, the baseline allows the client to identify appropriate concession points.

Sourcing Agendas

Coupled with aggressive cost reduction initiatives, pharmaceuticals are pursuing ambitious outsourcing agendas that extend beyond traditional back office operations to encompass business processes related to data management, clinical trials, reporting exceptions to drugs, and other areas.  As BPO providers are becoming increasingly specialized in terms of delivering solutions that address specific compliance and regulatory requirements, opportunities clearly exist for pharmaceuticals to successfully outsource many of these functions.

Since BPO solutions are tightly intertwined with IT systems, effective multi-vendor integration and management capabilities are essential. However, due to the industry’s relative isolation from cost containment pressure, pharmaceuticals tend to have a lower level of BPO sourcing maturity than some other industry verticals.  Even where high degrees of maturity exist, they are often centered around IT sourcing and these teams are often not effectively leveraged by other parts of the organization.

As a result, managing a multi-vendor model presents a significant challenge. While some firms are aiming to leapfrog their existing “outsourcing 101” capabilities, they may lack the internal knowledge to effectively manage a multi-sourced arrangement.  Another option is to outsource the role of vendor coordination and integration to a third party.  ISG has observed that this approach can be effective if the client organization lacks sufficient internal management and process maturity.

Managed services solutions are also gaining increased attention.  For firms that lack internal capacity, a managed services model can be a viable approach to addressing emerging challenges. Again, however, organizational maturity is an issue.  Pharmaceuticals are accustomed to having the bulk of operational resources on-site. Understanding how to run a globally resourced and geographically scattered managed service therefore presents a significant shock to the system.

M&A Activity

Merger and acquisition strategies also pose some pressing operational questions. Consider the scenario of a pharmaceutical that sells or splits  off parts of the business.  While the objective is typically to minimize the transition period, the divesting organization needs to understand how doing so will impact existing outsourcing deals. Specifically, what types of penalties will apply for early (or partial) termination? Are there minimum revenue commitments which will be impacted? And at what point do those penalties start to materially impact the benefits of spinning off the subsidiary?

Similar calculations are at play for large pharmaceuticals that acquire smaller niche players to incubate new products and foster innovation.  From an operational standpoint, is it worth the investment to integrate the new entity into the parent firm to standardize processes and systems? How would doing so impact existing outsourcing contracts? What’s the crossover point at which running the acquired entity as an operational stand-alone becomes more expensive than integration?

Addressing these questions requires detailed understanding of existing contracts, fact-based scenario models to evaluate the implications of alternative courses of action, and the ability to calculate and quantify a business case.

The days when pharmaceutical firms have been exempt from the rigors and requirements of operational discipline are clearly long over. Today’s firms have defined ambitious agendas and set aggressive goals to reduce costs and enhance organizational agility.  While the ticking clock of patent expiration warns against excessive caution, slashing operational costs for short-term gains with no regard for future business requirements is equally untenable.

Jon Lightman is a Director with ISG and heads up their Life Sciences practice. ISG is a global consulting, research and managed services firm.

 

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