New Rules -The game has changed for the global pharmaceutical industry. Numerous forces are shaping this new pharmaceutical era: The rise of emerging markets, increasing price pressure and expiring patents are just some of the factors forcing pharmaceutical companies to change the way they operate and how they manage their value chain.

"Drug Supply 2.0: How to manage a disaggregated pharmaceutical supply chain" is a study by Camelot Management Consultants and the ESB Business School Reutlingen that examines how companies are responding to the changed environment and looks at the growing role of third-party suppliers in the pharmaceutical business.

The interviewed companies are no newcomers to the field: 88% of the companies look back on more than 10 years of experience in sourcing supply chain services and already manage on average a portfolio of 214 suppliers. They count among the sector's forerunners.

Geographic Shift and Supply Chains

Although traditional markets account for the bulk of sales, "pharmerging" markets will outpace traditional markets in terms of growth by 2013. Given the environmental forces at play, pharmaceutical companies have no alternative but to make striking changes to their supply chains. A closer cooperation with contract manufacturers or R&D providers is the chosen option. This is not only the easiest way to partner in new and uncertain markets, it also enables them to manage increasing price pressures arising from health care reforms, patent expiry and the success of Generics.

Each of the four new strategic business models adopted by pharmaceutical business units - Harvesters, Rx Innovators, Gx Innovators and Branded Generics (fig. 1) - requires stronger partnerships with third-party suppliers to be formed to guarantee success. According to the experts interviewed, the potential for doing so is huge: Up to 75% of production volume could be reallocated to third-party manufacturing. Yet there are hurdles that need to be overcome. Managing a disaggregated value chain involving a growing number of third-party providers is a different game than managing own sites. More extensive and new forms of information exchange beyond the own company´s boundaries will be necessary to ensure productive planning.

This is increasing the pressure on supply chain management to create processes to steer this new virtual network, reducing the threats seen in know-how transfer, internal change process and increasing administrational costs. On a positive note: while the majority of companies still primarily let the manufacturing organization make supply chain disaggregation decisions, already one-third of companies have turned this into a boardroom decision.

Reshaping the Supply Chain

Abandoning the single minded blockbuster mindset, pharmaceutical companies have been forced to review their business plans and reconsider new business models as well as how they allocate their capital. Contract manufacturing organizations (CMOs) play a large role in the business models that are evolving. CMOs are increasingly being considered strategic partners, responsible for greater amounts of the portfolio volume, and less as step-in organizations to smooth out manufacturing peaks. This view is supported by this study's participating companies, which believe that this trend will gain even more traction over the next five years.

Most pharmaceutical companies already outsource activities such as clinical trials, API production or logistics to third-party suppliers. Over the next five years, pharmaceutical companies are likely to become more emboldened and will start examining all their technologies and business processes for outsourcing opportunities, according to the companies interviewed. When this happens, contract service providers will have made the jump from service to strategic partner.

Based on the experience and roadmap of other industries like automotive and electronics, pharmaceutical companies are likely to make this change in three phases:

Phase 1: Early wins
In this phase companies focus on low-risk support functions such as finance and accounting, IT and HR as well as low-risk R&D functions such as clinical development and data management.

Phase 2: Phase 2: Minimal risk move
In the second phase, companies are prepared to move out of their comfort zone and start outsourcing contract service functions such as bulk drug manufacturing and packaging, API production and 3PL. They are also likely to consider the outsourcing of R&D activities including bio-informatics, analytic services and Phase III clinical trials. Other functions like the sales force are also outsourced during this phase. Companies are encouraged by the significant bottom-line impact and variabilisation of their cost base resulting from this outsourcing and spurred by the emerging vendor base already built-up by some big pharmaceutical companies.

Phase 3: Phase 3: Collaboration
In the third phase, companies start collaborating with third-party suppliers, seeing them more and more as trusted strategic partners. Outsourcing leaders will sign contract partnership deals involving new product development, full single/multi-market supply as well as direct to pharmacy by 3PL. At this stage, R&D outsourcing involves lead generation and optimization. Increasingly, support functions such as planning and data services will also be outsourced.

The Rise of the ‘Pharmerging 17'

The second major pressure front forcing pharmaceutical companies to alter their supply chains radically is the explosive and continuing growth of the emerging markets. While traditional markets are growing at a steady single-digit level, the "pharmerging markets" promise growth of up to 15% over the next few years. These emerging pharmaceutical markets are generally divided into three tiers:

• Tier 1: China
• Tier 2: Brazil, Russia and India
• Tier 3: Venezuela, Poland, Argentina, Turkey, Mexico, Vietnam, South Africa, Thailand, Indonesia, Romania, Egypt, Pakistan and the Ukraine

The sheer size alone of the population in the tier 1 and tier 2 markets creates tantalizing opportunities for pharmaceutical companies that manage to establish themselves in these countries. In addition China still provides a good hub to enter Africa beyond tier 3 markets due to China's good relationships with markets in central Africa.

Established companies should by-pass the tried-and-tested business models that they use in the traditional triad markets North America, Europe and Japan and opt for new models to address the emerging markets. Given each country's unique market dynamics, health care system, political and regulatory environment, experience in dealing with established western players and general ways of doing business there is no generic blueprint for success.

Navigating the Global Supplier Landscape

The local nature of contract research outsourcing (CRO) and CMOs makes them ideal partners for entering these unchartered and unfamiliar markets. Partnering with CROs and CMOs will make it easier for established pharmaceutical companies to get a toehold in these regions. In some respect, pharmaceutical companies will have no other choice:

Stricter import regulations, for instance, will force pharmaceutical companies to either invest directly or enter partnerships with local players if they wish to be active in the market. Business constraints also encourage pharmaceutical companies to get involved in joint ventures, R&D partnerships, strategic business collaborations, and to gain more experience in out-licensing and outsourcing. Lower per capita health care spending, for example, means companies must offer products at a lower price. To accomplish this without exposing profits to risk, bigger amounts of the supply chain will need to be shifted to local partners.

For many companies, it just makes good business sense to have strong partners on the ground who understand the local market and who can quickly respond to changing conditions. This is how the needs of local customers can be met. Other companies will prefer to collaborate closely with hospitals and medical centers in specific regions.

Combined or full service providers like CRAMS (contract research and manufacturing) will continue to provide the highest growth opportunity. Some of the bigger contract service providers could start to lead the global market concentration. Also private equity firms could start to concentrate the low end to build competitive full service suppliers.

The New Strategic Pharmaceutical Business Models

Tectonic shifts in the pharmaceutical industry have compelled companies to take drastic action in order to secure their long-term survival. With the blockbuster strategy of the past decade losing currency, pharmaceutical companies have increasingly been branching out into new business areas. The business segment strategies of big pharma of the future are more versatile than as seen in the past:
Big pharma - referring to top 20 pharma by sales - have redefined their strategy mainly by differentiating into four business models, which we can be segmented in the clusters "Harvesters", "Rx Innovators", "Gx Innovators", and "Branded Generics."

These business models are far more diversified than the old blockbuster one and open up new opportunities, especially for companies that can rely on no strong pipeline.

Put simply, Harvesters expand their portfolio by making a broad range of highly differentiated products for new markets, Rx Innovators divest assets to focus on developing new drugs, Gx Innovators add value to expired patents with their low-cost and narrow focus, and Branded Generics produce a broad range of products at low cost (fig. 1).

The Road Ahead

Turning away from the blockbuster business model, pharmaceutical companies are concentrating on their core competences and increasingly exploring avenues to shift product volume to third-party manufacturing to keep their own assets low. The expected cost reduction from disaggregating certain supply chains amounts to 43% on average COGS basis, providing an exceptionally good reason for hesitant pharmaceutical companies to wholeheartedly embrace this trend.

The products and functional services most pharmaceutical companies are prepared to source from a third-party provider within the next five years are still limited, in terms of their cost saving potential as well as their complexity. As a whole, pharmaceutical companies are just starting to jointly develop products or innovations with service providers. The dual-pressure fronts arising from the collapse in profitability in established markets and strong growth in pharmerging markets make this an untenable position, even in the medium term.

CMOs are being offered an opportunity - and they must rise to the challenge. Pharmaceutical companies have set out in no uncertain terms their expectations about working with third parties. They have made clear the conditions that must be fulfilled before engaging third-party suppliers in intermediate release, finished goods release, electronic information exchange and collaborative planning. Service providers would be wise to act quickly: Those that partner successfully with pharmaceutical companies can expect substantial business opportunities, involving the supply of large volumes and the chance to become an integral part of the supply chain.

But first they must become capable of providing a full-service offering - whether in logistics, warehousing or quality functions. By standardizing their IT systems to enable automatic information transfer they will win the favor of global pharmaceutical firms. Top ranked third-party providers must not shy away from asking for investment support. And most critically, they must show that they themselves are lean organizations with a business firmly focused on excellent delivery, cost effectiveness and continuous improvement.

You can order a copy of the study free of charge at:
http://www.camelot-mc.com/en/press/press-releases/

Read our interview with Camelot's Michael Jarosch and Ulrich Korneck here.