THE EVOLUTION OF PROCUREMENT IN THE PHARMACEUTICAL INDUSTRY

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In today's challenging environment, aggressive cost control has become a common theme

in the pharmaceutical industry. It became fashionable later than in most industries but

today it is with us, and it is here to stay:

For the traditional pharmacos, the generics are putting a lid on the revenues from

older products. For the generic manufacturers, low cost is a way of life.

Many social security systems, generating a large part of the revenues of the

industry, are facing challenges because there are insufficiently funded and their

ageing members have increasing needs.

Emerging nations represent a growth opportunity but cannot afford expensive

medications

Last but not least, Research, from discovery to clinical trials, is increasingly

expensive, while the payback period decreases.

Often, before cost pressures forced the implementation of a new Procurement organization,

the function was mainly structured to administer Purchase Orders and perform basic

quotation requests. Then, we implemented the tools and the culture previously found in

other industries such as consumer products or assembly. By consolidating volume across

plants and harmonizing specifications, Procurement forced suppliers to improve terms.

Often, consultants sped up the process and built organizational skills, with double digit

initial cost reduction, followed by smaller annual improvements. Negotiation skills were

creating value by lowering the cost of the Bill of Material. Although this is far from

today's best practices, it marks the realization by upper management that the Procurement

function had more to contribute than offering transactional administrative support.

Profit margin improved for a few years, fuelling investment in better systems, and

attracting a new breed of good managers. They introduced a more strategic vision of the

entire supply chain, gained insights on the Total Cost of Ownership (TCO) and

redistributed responsibilities to reduce the TCO with cross-functional initiatives. EProcurement

solutions provided an additional transaction cost reduction. The most

powerful companies sometimes convinced their suppliers to open their books, discuss their

cost structure and offer new ideas to optimize interfaces, setup and management costs.

Reaching this level required that firms rethink their organization, their staffing approach.

Those changes could only be justified with a long term vision of the Procurement function

and its relation with the other functions in the firm. Nimbleness, flexibility, a culture open

to change, those were the common traits of the new winners. The changes were therefore

of strategic nature, to capture advantages through excellence in execution.

Another change occurred. Procurement extended its responsibilities to support

maintenance then capital investments. The support functions were also taking the

opportunity to leverage Procurement to control better their budget. Today, most

pharmaceutical companies have a professional procurement team dedicated to reducing the

cost of services, from office supplies to marketing spend such as events and research.

But is this new culture of Procurement sufficient? Where will it lead us? Other industries

like automotive or electronics have gone this path before us, but relentless cost cutting did

not save GM from the brink of bankruptcy, did not prevent Compaq from being acquired by

HP, and was not sufficient to satisfy HP's shareholders after the merger. So what is

missing? Can Procurement deliver more? How should CEOs view their Procurement, and

what should be their objectives?

From Tactical Cost Cutting to Strategic Supplier

Management

"The key to investing is not assessing how much an industry is going to affect society, or

how much it will grow, but rather determining the competitive advantage of any given

company and, above all, the durability of that advantage"i . The Pharmaceutical industry

today is especially under pressure to increase shareholder value. This must become an

objective for all the functions of the firm, including Procurement, which in turn must

reassess its role and its culture. But how many Procurement Professionals in our industry

have asked themselves "What am I doing better than my competitors?"

To contribute to the success of the firm on par with the other functions, the Procurement

team must focus on identifying and capturing strategic advantages, impacting revenues in

addition to profit. When Procurement is capable to have that much impact on the future of

the Firm, it deserves to be on the CEO and the Shareholder's agenda.

When Procurement became an agent of change in a cross-functional approach to optimizing

the Total Cost of Ownership, its impact was transactional effectiveness (defined as "level

2" above). It improved the relation between suppliers and the value chain of the firm,

working together to solve problems more efficiently: design, logistics, value engineering,

etc. were discussed. But this approach is not intrinsically differentiating because it has

been discussed at length and implemented by many enterprises. Nothing in this approach is

proprietary, unique, or differentiating. Firms that have not adopted a "level 2" in

procurement are lagging, but reaching "level 2" is not a guarantee of being ahead for a

significant time.

The complexity of relationships in our industry has increased significantly. Innovative

molecules and solutions are not systematically developed in house, and then manufactured

in integrated plants starting with basic raw materials. We leverage a network of biotech

firms, and academic research institutes for some part of our innovation. We outsource to

low cost Far-East facilities the production of bulk chemicals, and to nimble secondary

manufacturing specialists the packaging of our products. We rely increasingly on CRO's to

support clinical research and farm out data management to India or South Africa. Health

Economists and Key other experts provide advice and support to our commercial

departments.

So in our innovation driven environment, external resources have become increasingly

important to value creation. But an innovation that is accessible equally to all players in an

industry builds only value to the final users. Therefore, it is important to manage the

sources of innovation to build an extended enterprise rather than a loose relationship that

will change direction or be broken with the winds of commercial relationships.

Today, the Procurement leadership must develop key suppliers to exploit quickly their

skills to their advantage rather than for the benefit of the industry. It must contribute to

shaping supplier's strategies to speed entry into new markets. To do so, it must dedicate

resources to facilitate seamless and exclusive transfer of value from the suppliers'

development labs to the final consumers and back. That is the reason why Procurement

must understand the lifecycle value creation potential of an item, not only as a driver of the

Total Cost of Ownership but, more importantly, as a driver of product pricing through the

premiums provided by exclusivity, and/or market growth for the company. Those types of

initiatives can only succeed if both partners have common goals, and the trust that both will

work together rather than exploit a weakness of their associate at the first opportunity. It

does not mean that cost cutting strategies are obsolete. They have become necessary rather

than sufficient. They will be useful to manage a large portion of the addressable spend, not

the entire spend.

This strategic sourcing approach, called "Collaborative Sourcing", is differentiated from

transactional effectiveness. It can deliver superior returns because it aims specifically at

creating a gap between the firm and its direct competitors to create sustainable competitive

advantages. Another impact is the securization of long-term strategic materials and

resources. Transactional effectiveness only aims at improving the operational aspects of

the relation, not to build value for the extended enterprise in a competitive environment.

Transactional effectiveness is often driven by a buyer at "level 2" who imposes its working

approach on all its suppliers forced to go along or be replaced by more compliant

alternatives. It can also be the result of an industry wide effort, often pushed by solution

vendors.

Collaborative Sourcing requires a radical change in the culture and the vision of the relation

between the buyer and the supplier. Collaborative Sourcing can involve more than two

companies, such as a supplier of raw materials, a packaging manufacturer and a final user.

Therefore it is clear that Collaborative Sourcing goes beyond the performance of similar

activities better than one's rivals. It is a deliberate attempt to reposition the company by

using different and distinctive approaches to managing suppliers. Few companies have

competed successfully on the basis of their better effectiveness over an extended period.

Collaborative Sourcing is the strategic repositioning of the supplier relationship

management. Collaborative Sourcing experts define, search, capture, isolate, manage and

improve resources internal and external to the firm to deliver strategic advantages by

optimizing internal and external working relations. Collaborative Sourcing relies on trust

between involved parties.

Comprehensive External Resource Management

Moreover, leveraging innovation requires the input of many functions in the firm.

Therefore a sourcing strategy aimed at value capture relies heavily on collaborations within

the firm. Building and managing this collaboration is a complex task that can only be

effective if it is properly orchestrated: this is the role of the Sourcing Manager in the

Procurement team.

So Collaborative Sourcing is not only a change in the relation between the Enterprise and

its suppliers. It is also a change in the relation of the Sourcing Managers and the other

functions. In the past, Procurement was only involved when the products hit the supply

chain, usually at the industrialization phase or later. Unfortunately, this approach presented

a few weaknesses:

The scientists are often focusing on obtaining products or services to solve a

development problem, rather than a supply chain issue. Therefore, they may not

take in account all the parameters involved in long term value creation

Although some scientists combine brilliant research capabilities with business

savvy, many others have less inclination for negotiation, long term cost benefit

analysis, or similar skills that a modern Procurement professional must master.

Last but not least, good scientists are in short supply, so why ask them to stretch

themselves to cover tasks that others can do faster and more naturally.

To support Research activities, Procurement must be involved in securing sufficient supply

of a hard to find molecule. While the current needs may be for a few hundred grams of

laboratory grade product, the long term growth of the company may require a thousand fold

increase or more, with radically more complex specifications and service requirements,

capable of entering into a GMP production environment, satisfying strict regulatory

constrains.

Another area for Procurement involvement is the Clinical Research. Here we are not

speaking of the mere improvement of contracts with CRO's or academia. Today's

Procurement best practices will support a much more strategic and fruitful collaboration

through the application of all the tools of the trade: the transparency tools like cost

modelling, the specification tools like benchmarking and process reengineering, in addition

to the traditional negotiation tools.

Procurement must be a natural partner to all the functions in the Enterprise. Nobody but

the finance team identifies and secures funding for a new research or a marketing initiative.

Human resource professionals manage compensation, and recruitment. The IT department

develops and maintain the architecture of systems supporting all other functions. Likewise,

if it is an external resource, it must be managed by the specialists in the Procurement

Department (Figure 2).

To be effective contributors to the strategic issues of the Enterprise, the Procurement

leadership must work closely with the other senior executives in charge of key functions.

This can be done through an ad-hoc steering committee, usually with the Finance,

Production, R&D and HR leaders. Increasingly, the executive in charge of Procurement

reports directly to the CEO and sits on the executive leadership council. In this case, this

executive is usually a Chief Procurement Officer, a CPO.

The role of the CPO is to optimize all the relations with external suppliers, a much broader

role than the traditional cost cutting approach. It complements the transactional activities in

the supplier relationship with Sourcing defined as "The process of identifying

opportunities, evaluating potential sources, negotiating contracts and continuously

managing supplier relationships to achieve corporate goals"ii.

Conclusion

In a world class Procurement organization, the potential for creation of shareholder value,

not merely the preservation of it, is an intrinsic part of the role of Procurement. The

Capital:

CFO

Labor:

VP HR

Information:

CIO

Resources

R&D Production Commercial

eXternal:

CPO

Capabilities Building

Support Legal Corp Strat

Value Creation Framework

function must be a contributor to strategic differentiation: not only being excellent in

executing transactions but also identifying where it can contribute to develop sustainable

competitive advantages. Obviously, there will always be a sizeable part of the portfolio

that is spent on suppliers that bring no opportunity to differentiate (Figure 3). Those will be

managed traditionally to reduce total cost of ownership. Industry-wide solutions, processes

to improve transactional efficiency, will be used to stay at the front of the race. And for

select relations, collaborative relationships will be developed to build value and support

growth.

The Author

Michel Philippart is in charge of Sourcing and Procurement for GSK Biologicals, the

vaccine division of GSK. Prior to joining GSK, he worked for consumer goods companies

such as PepsiCo and Consulting firms such as McKinsey. He is working on a book on

"Collaborative Sourcing" with Christian Verstraete and Serge Wynen (available in

September at i6doc.com)

i Warren Buffett, Fortune, November 1999

ii Pierre Mitchell, AMR Research

iii Collaborative Sourcing, Philippart, Verstraete, Wynen, September 05, Presses

Universitaires de Louvain

Figure 3: Mature Portfolio of Supplier Relationshipsiii

Traditional Procurement

• Adversarial relationships

• Clear objective to reduce cost of supply

Procurement Collaboration

• Operationally oriented

• Reduction of cost of doing business

• Electronic transactions (eg. PO)

Sourcing Collaboration

• Establishment of collaborative

approaches to do business (eg. VMI°

• Sharing of planning information

• E2E Integration of sourcing processes

Value Chain Integration

• Collaborative relationship from product

development onwards

• Joint investments

• Joint go-to-market

Collaborative Sourcing

• Development of tight relationships to

ensure long term partnerships across

all business aspects

• Exclusive capture of resources

• Strategic alliances and acquisitions

Level of Collaboration

Potential for SCA

Percentage of Suppliers Involved

Value

transfer

Sustainable

Value

Creation

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