My fellow MedPharma Partners co-founder Patrick Kager and I have an article in this month’s Pharmaceutical Executive magazine entitled How Do You Solve a Problem Like Manufacturing? Pat is our pharma manufacturing guru at MedPharma Partners and the article reflects his deep experience in consulting to big pharma, biotech and contract manufacturers.
Manufacturing isn’t well understood within pharmaceutical companies. Top management and board members typically have little background in manufacturing and the head of manufacturing usually reports to someone in the commercial organization rather than directly to the CEO. It’s unusual for the head of manufacturing to sit on the executive committee at big pharma companies. When top management does examine manufacturing –usually at the behest of the CFO– they are surprised to find how much capital is invested and how low capacity utilization is. “Why don’t we just outsource it?,” they ask.
Especially in these times of cost cutting, moving to a fully outsourced model seems like a good solution. But actually, there are good reasons not to rush down that path:
- It’s hard to dispose of the existing assets. Unlike in consumer electronics there are few companies capable of buying and running the facilities. Exceptions –like Catalent (formerly Cardinal) and Patheon –are subject to acquisition by private equity funds or to screwing up their operations and getting into trouble with the FDA.
- Owning manufacturing plants can yield tremendous tax advantages, which are difficult to replicate in a purely outsourced model (though there are ways to achieve some of the benefits through tolling)
- There are increasing opportunities for tight integration between pharmaceutical development and manufacturing, and the interfaces between the two can be much more robust in an in-sourced model. Truly new drugs are rare within pharmaceutical company pipelines. New combination products and modified release formulations require advanced manufacturing knowledge
- Manufacturing costs are a very low percentage of revenue for pharmaceutical companies. Even in these tighter times it makes good sense to keep spare capacity and go overboard on spending on quality and support services. However contract manufacturers look at the world differently. What represents a mere 5 to 20% cost of goods sold for the pharma company is 100% of the contractor’s revenue. They are more prone to squeeze out spare capacity and take shortcuts elsewhere simply because they have a greater economic incentive to do so. That can lead to trouble
- Recent troubles in China and India reveal the dangers of losing control of the supply chain
That doesn’t mean pharma should use a purely insourced model either. In general, pharmaceutical companies should make greater use of third-party manufacturers. Left to their own devices, manufacturing divisions will look to keep everything in house. And with top management not understanding the fundamentals of the business, it’s easy for the manufacturing folks to exaggerate the dangers of third parties and present unfair cost comparisons. A favorite approach is to compare the marginal costs of in-house production with fully loaded third-party costs, something we explore in greater depth in the article.
Pat and I are available to discuss this topic at greater length so if you’re interested please send us an email.September 24, 2008