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 / Spring 2012 / Issue 66(originally published by Booz & Company)


Five Steps toward a Revitalized Pharmaceutical Supply Chain

Global drug companies are facing disruption. One powerful strategic response is to rethink their manufacturing and operations footprints.

Sooner or later, every industry faces a moment of truth, when its leading companies must fundamentally rethink their supply chain. In many cases, the old practices have held sway for decades. Isolated decision makers pursue transactional arrangements with their suppliers. There is minimal communication, little effort toward mutual improvement, and no real desire to pursue efficiency gains. Regulatory constraints and favorable tax structures in a limited number of manufacturing locations work in the industry’s favor. Steady profits are derived from captive customers dependent on the industry’s products. All this has made changing the status quo unpalatable, or at least unnecessary.

But then a disruption comes. Perhaps it takes the form of breakthrough technology; or changes in customer demand patterns; or new, more nimble and innovative rivals. To respond — to cut costs and become more agile — industry leaders rationalize their sourcing and distribution, and add operational efficiencies. Although they are reluctant to make these moves at first, companies soon discover that seemingly modest shifts in supply chain strategy can transform their industry and dramatically boost performance. Haltingly at first, and then in a great wave of activity, the prevailing practices of the industry change. It happened to automobiles and chemicals in the 1980s and 1990s and to consumer packaged goods in the 1990s and 2000s. Now it’s the turn of pharmaceutical companies.

Virtually every major pharma company is confronting a far different and more troubling business environment than it faced even a few years ago. (See “Big Pharma’s Uncertain Future,” by Alex Kandybin and Vessela Genova, s+b, Spring 2012.) And like companies in other industries before them, established pharmaceutical companies must manage this disruption in a way they perceive as unfamiliar and unorthodox. They must view their supply chain in a new, strategic light, as a potential competitive advantage rather than an unavoidable cost center embedded in day-to-day operations. In the process, they must discard age-old attitudes that once drove nearly uninterrupted success.

The biggest disruption is the new influence of a familiar presence: generic drugs. In the past, patent protection ensured that multinationals faced little competition for blockbuster drugs, which in turn allowed the drug manufacturers to maintain high price points and margins on each pill, ointment, or liquid sold. Now, that is changing. Although over-the-counter and other generic pharmaceuticals have been around for many years, their impact is more unyielding now than it has ever been, and it will become even more pronounced in the next few years as big-name drug patents expire. Of the 20 highest-grossing drugs in the world today, 18 will lose patent protection before 2015 — among them Lipitor, Plavix, and Nexium. All told, drugs worth about US$400 billion in revenue will be open to generic competition by 2015, according to the IMS Institute for Healthcare Informatics, a market analysis firm; that will represent about 40 percent of the pharmaceutical market worldwide, up from 27 percent in 2010.

The pharmaceutical companies have responded to generics in the past by developing new blockbuster drugs, but that will not be an option this time. Few such drugs are left in the R&D pipeline, primarily because the science of drug development has become extraordinarily complex. Much of the low-hanging fruit in the pharmaceutical world — remedies that effectively address health problems for large markets — has already been plucked. In addition, regulatory approval for new products in many parts of the world has become much stricter and less favorable to big pharmaceutical investments. The impact of this product development slowdown is reflected in ballooning R&D costs and declining R&D productivity. Globally, pharmaceutical companies spent about $130 billion on R&D in 2010, up from $54 billion 10 years earlier, yet the total number of new drugs approved by the U.S. Food and Drug Administration fell to 28 from 33, according to market analyst EvaluatePharma.

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