It Will All End in Tiers
Rupert Booth discusses issues arising from Bio/PharMOS 2002.
Views of the Mediterranean coastline were not the only ones offered to delegates attending last month’s Bio/PharMOS conference in Monte Carlo. Speakers provided delegates with many different perspectives, some of them apparently contradictory. For example, on the one hand, speakers from large pharmaceutical companies were asserting they wished to deal with fewer suppliers; but on the other hand, other speakers highlighted the number of Contract Manufacturing Organisations (’CMO’) had been growing steadily for years. Furthermore, despite the priority given to marketing and research and development in competition for funds, there was concern over compromising the secuirty of product supply by outsourcing manufacturing too widely.
How can these opposing views be reconciled? Most likely by a rationalisation of the supplier base into large "first-tier" suppliers and a large number of smaller, "second-tier" suppliers. Therefore there will always be a place for the small CMO, competing on niche skills or high flexibility, however such companies may no longer service large pharmaceutical companies directly, but via a large first-tier CMO.
The large pharmaceutical companies will most likely seek out a few large CMOs and enter into long-term partnerships with them. They will select on the basis of assurance of quality, security of supply and financial suitability, not ignoring, of course, supply chain effectiveness in terms of low cost and flexibility of supply. In making that of the selection the emphasis will move away from meeting a series of short-term requirements in an unstructured way to a strategic view of outsourcing, viewing the CMO as part of the extended enterprise. These long-term partnerships offer a number of advantages.
Compared to vertical integration or acquisition, they will avoid paying a premium price for the company and furthermore ensure the supplier still faces competitive pressure. The supplier also retains access to the latest ideas in the market and an entrepreneurial spirit, possibly reflected in flexible remuneration systems.
Compared to arm’s length trading, partnerships offer a reduced transaction cost in dealing with fewer suppliers, the full benefits of experience curve effect by concentrating production and a willingness of the supplier to invest in the on term. Furthermore extending the enterprise to include the supplier spreads development cost and risks and allows the pooling of expertise. These factors are summarised in Figure 1.
[Figure 1]
The partnership itself can take a variety of forms. Taking an equity stake in the partner is the most explicit from of commitment and ensures board-level participation and consequent alignment of strategic plans. If its is not thought appropriate then it is possible to enter into contractual arrangements, including those that guarantee a certain level of business, in order to provide confidence for future investment. At a minimal level there may simply be a memorandum of understanding.
Beneath the large CMO, we will then see an additional tier of suppliers forming, in many cases forming partnerships with the larger CMO. The natural conclusion will be an evolution of the supplier base into the "tiered" arrangement, as seen in the automotive sector, where large vehicle manufactures deal with relatively few major suppliers, who then deal with the smaller suppliers. Not all these trading relationships will involve partnerships, however, indeed new opportunities such as e-procurement allow for the increase of competitive pressure
What does this mean for the various participants within the pharmaceutical industry? The first requirement is a major revision of information systems that measure cost and performance. In vertically integrated industries, such as the pharmaceutical industry of the past, the information systems concentrated on reporting cost by department, to assist managerial control. If an extended enterprise business model is adopted, then it becomes crucial to measure the cost profitability of trading relationships. Furthermore true partnership trading implies negotiating around cost models as opposed to a price, in order that the cost and benefits of joint improvement programmes can be identified and the net benefit shared. This implies an investment by all parties in activity based costing, especially around the trading and logistics processes.
Secondly, knowledge management has to be explicitly addressed if an extended enterprise is to function effectively. Knowledge communities need to be identified and formal processes for the creation and sharing of knowledge as well as attention to the technology infrastructure, as illustrated in Figure 2.
[Figure 2]
Finally, it must be recognised that in an extended enterprise the supply chain planning and execution is more complex. There is a need to synchronise the operations of the internal supply operations and those of the external supplier, if excessive inventory or poor resposiveness is to be avoided. Here Web-based technology is providing a useful boost, with the Extra-nets being used to ensure good links with suppliers in a convenient and controlled from.
The pharmaceutical and biotechnology industries continue to evolve towards greater consolidation (by comparisons with other sectors, the industry is still not especially consolidated), away from vertical integration and towards a value chain based on extended enterprises. The next stage of the evolution is for the larger CMOs to consolidate into a few large companies, forming the first tier of the supplier base. As this strategic realignment proceeds it will create the need for new business processes and information systems to underpin the new forms of trading.
Rupert Booth is a Director of i4profit ltd. A copy of the paper he gave to the Bio/PharMOS conference can be obtained from info@i4profit.net
Keywords : Contract pharma manufacturing Supply chain management Rationalisation Strategic realignment
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