The Importance of Supplier Management

A sponsors perspective on achieving operational success

By Hany Salama, ME (Hany Salama, ME, is manager, supply management at Hoffmann-LaRoche. He can be reached at hany.salama@roche.com)
To become competitive in the pharmaceutical industry, many top-tier pharmaceutical organizations consistently ask their supply chain organization to increasingly contribute to their bottom line. Profitability has come from continuous cost cutting, rather than top-line growth. Outsourcing of manufactured and packaged pharmaceutical products has gained popularity for a number of reasons. The most significant reason is that large Pharma executives have realized they need to focus on their core competency, drug developmentin which the company is working to identify new moleculesrather than managing the manufacturing and packaging of product. Thus, large Pharma organizations outsource to contract facilities in order to ensure quick turnaround in bringing products to market, as well as developing a total turnkey process in which the vendor manages the manufacturing and packaging operation. Another reason for the increase in pharmaceutical outsourcing in the past few decades is that companies are experiencing a fluctuation in demand for various prescription and OTC products. With many products coming off patent and uncertainty as to whether or not products will survive in the market place, pharmaceutical companies have eschewed the multi-million-dollar construction projects of manufacturing buildings and turned to contracting companies to meet their manufacturing and packaging demands. The challenge now is how to manage the product at the contractor and subcontractor facilities. A total vendor management system must be established to allow visibility to the product-owning company. Included in the vendor management program is a system of checks and balances from a regulatory, quality and overall supply chain perspective. The questions now become: What are these contract facilities and what can they do to streamline pharmaceutical manufacturing and packaging operations? Current and Future Outsourcing Activities Outsourcing of manufactured and packaged Pharma products is the process by which a pharmaceutical company utilizes external contractors to fulfill the demands of its product line. That is, a third party facility now becomes the site of manufacturing and packaging for the product. This process can range from a single step of the manufacturing or packaging operation to the entire chain of activities. Many pharmaceutical companies have come to a point in which they provide the contractor with the Active Pharmaceutical Ingredient (API) and have the contract facility conduct all the manufacturing and packaging operations. There are many steps involved in the manufacturing of pharmaceutical products, including granulation, mixing, fluid bed drying, sieving, milling, extrusion and lyophilization. Packaging includes such processes as bottling, blister packaging, tube fill, suspension fill and some other forms of primary, secondary and tertiary packaging.

Outsourcing of manufactured and packaged products in the Pharma industry is projected to experience double-digit growth over the next few decades. As industry pipelines continue to shrink and the viability of products continues to be unstable, Pharma companies will increasingly turn to contractors to fulfill their product demands. According to the Pharmaceutical Contract Manufacturing Marketplace study conducted in 2002, the global pharmaceutical outsourcing sector is an $8 billion business and is expected to see a 25% increase by 2005 as companies are gearing up for the development of new molecules and the launches of products that are currently in Phase II and Phase III of clinical research. A long-term outsourcing relationship allows the supplier to invest in ongoing improvement of infrastructure and processes while developing better methods of manufacturing and packaging of pharmaceutical products. Outsourcers can take under-invested processes, build economies of scale, and leverage their process expertise and supply chain management, thus achieving improved operations and lower costs to achieve the bottom-line objectives for the pharmaceutical companies. As previously mentioned, manufacturing and packaging facilities perform some or all of the operations involved in a finished product. Depending on the size of the contract manufacturer or packager, it may choose to focus on only a few technologies or on all technologies involved in the manufacturing and packaging of a Pharma product. For example, Cardinal Health, best known as a warehousing and distribution giant, has been expanding exponentially during the past 10 to 15 years into other areas involved in the pharmaceutical and biotechnology sectors. Cardinal Health has taken on the entire manufacturing process for tablets, capsules, wafers, and suspensions along with the various packaging configurations involved with each of these product presentations. However, not all contracting companies take this route. Many companies focus on core competencies and look to optimize everything involved in that area so that they become the subject matter expert in a particular technology for the pharmaceutical company. By developing an expertise and operating an efficient end-to-end supply chain, contract companies are able to reduce cost and offer pharmaceutical companies competitive pricing (and in some cases better pricing) than a fully burdened cost at the pharmaceutical company. Outsourcing Trends Within the Pharma Industry: Outsourcing has increased primarily in large pharmaceutical companies as an effort to focus on core competencies and in order to reduce overhead. Companies increasingly outsource production to contract manufacturers to decrease costs and reduce or eliminate the expensive overhead involved in maintaining production facilities, as well as to take advantage of expertise of proprietary manufacturing and packaging technologies of the contractor. A recent study indicates that as much as 25% of manufacturing and packaging activities are outsourced at some of the top-ranking pharmaceutical corporations. In further discussions, the pharmaceutical companies indicated they expect an increase in contract manufacturing and packaging of their current and future products in the coming years for several reasons. The following reasons demonstrate why global outsourcing will increase among the pharmaceutical companies interviewed: Rich pipelines in which existing manufacturing and packaging facilities cannot support the additional manufacturing and packaging capacity Global restructuring of products and manufacturing strategies which results in a search for inexpensive manufacturing and packaging sourcing and closure of existing

operations, which are not cheap to operate Tax implications Future investment in drug development rather than facility expansions and upkeep Expedited product launch timelines that do not allocate enough time for facility upgrades Product and service cycle times have reduced dramatically, and time-based competition demands quicker response Small, agile niche competitors can now change industries and cost structures overnight Flexibility of contract facilities can absorb fluctuations in product demands.

After careful analysis of trends in outsourcing within the pharmaceutical industry, the logical questions now become: How does that business sector operate and what mechanisms are put in place to assure appropriate supply management relationships are developed and maintained? What is Supplier Management And Why It Is Important: The term strategic sourcing has become popular during the past few years within the supply chain operational arena. This term refers to a methodology of building a network of relationships with contractors, suppliers of raw materials, etc., for the use of both direct and indirect operations to support a pharmaceutical company. Particularly in the pharmaceutical industry, the system of strategic sourcing for contractors has gained much attention. Now that outsourcing has become a way of life for many of the major pharmaceutical companies, a methodology of checks and balances needs to be established to manage the relationship with an outside partner while maintainingor in some cases surpassingtheir own operations standards and requirements. Supplier management refers to the process by which the buyer of a contracted product manages the relationship with the vendor through metrics of key milestone performance measures. Instituting a system of supplier management through contractual agreements, both in supply and quality, allows the pharmaceutical company that is outsourcing the products to have a presence at the contractor and the ability to assess whether or not the contractor is performing as well or better than the established standards that were developed and agreed upon by both parties. In recent years, increasing numbers of pharmaceutical companies have developed long-term strategic partnerships with contract manufacturers and packagers to pursue mutually beneficial opportunities for cost reduction or for allowing the sponsor to focus on other goals. Pharmaceutical companies usually begin this relationship as early as two years before the actual manufacturing or launch of the product due to the period required for regulatory approval as well as technology transfer to the future site of manufacturing or packaging. During this period of development, both the sponsor and the contractor work out the logistics of the relationship from business and technical perspectives. This relationship usually begins when both companies sign a confidentiality agreement, allowing both companies to discuss intellectual property about the product or products to be outsourced. When a company decides to outsource to a contract service provider, a system of measurements needs to be established, especially given the fact that the products are regulated by the FDA guidelines and other regulatory agencies. Once they start outsourcing products, pharmaceutical companies have begun to set up strategic partners, which, in theory, perform as an extension of their manufacturing and packaging operation. The strategic provider should approach the relationship as if it were part-owner of the business. It will not only want to perform the services requested, but also to participate in strategic planning meetings and share in the companys strategic decisions about

manufacturing and packaging operations. In turn, the alliance company measures the performance of the contractor through a variety of tools: environmental compliance, Good Manufacturing Practices (GMP) compliance, FDA and other agency compliance, overall relationship and Key Performance Indicators (KPIs) or balanced scorecards that may include measures of on-time performance, batch rejections, quality deviations, etc. Both the company and the contractor establish KPIs or balanced scorecards in order to set measurements for accountability, and to meet company supply and demand of product, as well as other such measurements in the supply chain operations process. Measurements of on-time delivery performance demonstrate the importance of the Manufacturing Resource Planning (MRP and MRP II) as well as the ability to meet the demands established by the companys sales and operating plan (S&OP). A measurement of batch rejections allows the sponsor to understand how the contractor is using the raw materials provided by the company. The sponsor (as well as the contractor) is very interested in keeping this number to a minimum, since a batch rejection means that the contractor has lost money invested into labor, materials, etc. for the manufacturing or packaging of the rejected batch, which will not be recuperated. Measuring quality deviations will identify the number of investigation or deviation reports during the manufacturing and packaging processes. Because the FDA and other agencies govern the industry, all contractors must monitor any deviations from the Standard Operating Procedures (SOP) and any issues experienced during the manufacturing and packaging process that are identified and documented on batch records. Other measurements may exist to allow a system of accountability for both the company and the contractor. This may include a guaranteed minimum volume quantity for the contract, which basically guarantees that the company will provide business for the term of the contract, not to go below a certain volume. This is particularly important because it affords the contractor adequate data for labor and machine capacity planning purposes. This makes the contractor more interested in dealing with the company and establishing a short- and long-term relationship and vision of future business opportunities. Although flexibility is paramount at the contractor, a minimum volume of business must be established in order for the relationship to be worthwhile to the contractor. Keeping a system of good faith negotiations is a must in order to establish a sound relationship and maintain a good supplier management program. How Does Supplier Mananagement Achieve Better Operational Success? Through the use of well-defined supplier management programs and good procedures for choosing contractors, the Pharma sponsors should expect to achieve better operational efficiencies and stronger compliance to FDA and quality standards. But what is a well-defined supplier management program? A supplier management program begins when the decision to outsource has been made by the organization. The following is a methodology that allows a company to begin developing the roadmap to proper supplier management programs. During the due diligence process, in which the sponsor thoroughly evaluates the contractor (technical capabilities, financial viability, business performance, etc), the company should review the following: What Is The Motivation Of The Supplier?

The sponsor needs to be assured that the contractor is not just using the sponsor and its name to get into the industry or establish its reputation. The sponsor must also make sure that the contractor has conducted business with competitors and is reputable when it comes to delivering according to contracted terms. Does the supplier have experience in the industry as it relates to your business? The sponsor should make sure that the contractor has significant experience in the pharmaceutical industry and is cognizant of the governing regulations. The sponsor must also make sure that the FDA has most recently audited the contractor with no citations. How Is the Contractor Staffed in Terms of Skills, Headcount, etc.? The sponsor must make sure that false promises are not being made during the negotiations. A contractor may promise to have certain skills and resources available during the manufacturing and packaging process, but, upon entering into the agreement, resources may become scarce and thus delivery of expectations will not be met. The sponsor should understand the nature of the relationship with the contractor. The sponsor needs to understand why the contractor is looking to enter into an agreement. The sponsor also needs to understand both the short- and long-term strategies of the contract. What work have they developed with other companies and to what extent? [Peer friendships and working chemistry with ones counterpart in the other company [are] important factors in long-term relationships.] The sponsor should approach the contract and relationship from a long-term perspective, but use short-term contracts as appropriate. The sponsor should understand the lifecycle of the product line that will be outsourced. This means understanding the demands and production planning forecasts. This information should be accurately communicated up front to the contractor so that a total product lifecycle is presented. However, the sponsor should anticipate future line extensions of the product driven by marketing or other such changes that might bring about additional work at the contract facility. Presenting this information up front will help the sponsor and the contractor, understand how the relationship will develop and will allow the sponsor to negotiate better buying power through economies of scale. The sponsor should identify a key resource to handle the product portfolio at the contract facility. Sponsors need to handle the accounts at the contract facilities the same way they deal with their own manufactured and packaged products. Depending on the amount of contracted products, some companies choose to establish a contract manufacturing department to handle the overall relationship and business aspects from the companys perspective as well as that of the contractor. If there is a good understanding and strong working relationship between the key management personnel of both teams, then such relationships tend to last a long time and are typically very effective. Research on outsourcing success has indicated that peer friendships and working chemistry with ones counterpart in the other company have been important factors in long-term relationships.

The objectives to be achieved by outsourcing must be quantifiable and must be established as criteria right at the start of the contract. If the sponsor can compare the performance with the pre-established objective, then the benefits of outsourcing would be clear. The contractor would know where it stands in meeting customer expectations. Well-defined performance criteria have quantifiable objectives, service quantities, quality, and customer satisfaction and are measurable against other providers. The contractor is encouraged to meet or exceed customer expectations by establishing performancebased pricing. When performance exceeds the criteria, the incentives apply, and when they fall short, penalties are imposed. This is a methodology used so that contractors have incentives beyond just gaining the contract with the company. The cost of an incentive for a contractor is minimal compared to the potential loss of product supply for a pharmaceutical company on prescription and non-prescription product. For a successful manufacturing or packaging contract relationship, it is best to have frequent formal review meetings. These meetings can explore what both teams are working towards and provide a high-level view of the goals and objectives. Product reviews and deliverables can be discussed at such meetings. At these meetings, members can examine deficiencies in the relationship and potential for training to bridge the cultural differences. The contractor personnel need to have ongoing training so that they align their business goals to the business objectives of the company. The issues driving the client need to be understood and the contractors service has to relate to them. Both parties to the outsourcing relationship will have their own cultures. These differences have to be recognized and bridged. Some of the ways to bridge this gap include organizing social events, providing education on company background, and participating in one anothers quality programs. Maintaining such relationships with the contractor indirectly impacts product quality. Doing so makes contractors more privy to how their sponsor organizations operate, and allows them to understand the sponsors expectations. Thus, taking all the discussed points and effectively implementing a robust supplier management program essentially allows the contractor to function as an extension of the companys manufacturing or packaging process. In theory, minimal deficiencies in communication of product quality issues, which would have a direct impact on supply of product, should exist. Problems with Supplier Management: Trends have indicated that pharmaceutical companies are outsourcing more and more of their operations; however, we have also seen that outsourcing of operations is not necessarily being handled appropriately or effectively. Many pharmaceutical companies out source products, but dont set up the infrastructure to manage this business. Rather than having a dedicated group to manage these operational functions, it has been found that companies are relying on their purchasing organizations to manage the manufacturing and packaging operations at the contract facilities. This is a problem because many purchasing or other department-related personnel are trained to manage contractors who supply both direct and indirect raw materials to the organization. Outsourcing manufacturing and packaging operations requires a different set of skills, which many purchasing personnel are either not trained or equipped to handle in their infrastructure support system.

In order to fully appreciate the value of supplier management programs within an organization, it is important to understand how it fits into the Supply Chain Management (SCM) portfolio. As discussed previously, there are three basic phases: First, the strategic sourcing phase, which is used to assess a vendors capabilities, financial solvency, quality of product/service and pricing. Second is the implementation phase, in which the contract is executed and the transition to the new provider begins. Third comes the supply performance management phase, in which the organization works closely with the vendor to meet and in some cases exceed service levels while developing strategic solutions for improving the overall relationship. Managing the outsourcing of products at pharmaceutical companies is important because it establishes the importance of measuring the operation; spend analysis, contractor performance and the total product life cycle. Supplier management involves understanding marketing and sales trends for the product in order to manage the relationship from an MRP perspective, as well as developing the total business relationship such that the contractor almost becomes an extended business partner of the corporation. Thus, this function must be given the utmost attention and management, as trends indicate that more and more pharmaceutical companies will be outsourcing products over the next decade. Having a centralized function that manages all these issues is critical to the success of the organization. A centralized function that manages operational strategies, product changes, third and fourth party raw material suppliers, pricing negotiations and contracts, and ultimately acts as the companys spokesman is imperative to achieve operational success. Many pharmaceutical companies have mismanaged outsourcing relationships, causing various issues within the organization, particularly from a regulatory and cost perspective. Since the industry is highly regulated, there is a strong need to monitor all activities of product outsourcing. Once a product is outsourced, the organization loses some control of monitoring product integrity. Some pharmaceutical companies have recently been cited by the FDA for quality and inconsistency issues between their own manufacturing and packaging facilities and those of their contracted products. These and many similar types of issues should typically be handled by the contract manufacturing group through a well-defined supplier management program. Assurance of robust and harmonized systems with the organization and the contractor is a major flaw within many pharmaceutical organizations and needs to be addressed in a timely manner to avoidance regulatory violations. Mismanagement of outsourcing relationships also costs the organization money. Inefficiencies within the pharmaceutical outsourcing business result in time and material loss, which directly impacts operating costs. Poor outsourcing relationships with weak infrastructure limit the ability of the contractors, directly affecting efficiencies and ultimately impacting cost. The cost implications arise from a lack of detailed tracking and proper sourcing at the vendor. The organization should be aware of the various pricing components at the vendor through routine monitoring. A thorough cost analysis of labor rates, manufacturing and packaging component parts can assure that the supplier is giving the best pricing, and can track any manufacturing or packaging operations that result in batch rejection errors that should be charged (in some cases partially charged depending on the contractual terms) back to the contractor. An overall contractor spend analysis should be conducted on a quarterly basis, depending on product volume, and be shared with the contractor so that both parties understand the cost structure and collaboratively share the responsibility to reduce costs through efficiencies in the operation. Many pharmaceutical companies have developed a department to handle contract manufacturers and packagers; however, some of the companies still have this role covered by another organization

within the company. In either case, most companies are realizing that the outsourcing operation within the pharmaceutical industry is no small task. In recent years, purchasing, operations and supply chain organizations began to work closely in order to develop a strong value chain while driving down costs. Pharmaceutical companies, along with many other industries, are leading the way by linking together different functional areas of expertise purchasing/strategic sourcing, technical operations/quality management, and supply chain operationsin order to yield outsourced products that meet quality standards, are on-time, and have minimal rejections and low cost. Organizations in the pharmaceutical industry need to acknowledge the current trends of outsourcing and benchmark their operations against these trends. For those companies that are currently utilizing outsourcing mechanisms to supplement their operation, an assessment and benchmarking of best practices must be conducted with other industries in order to gauge and determine what is needed to be a best-in-class in supplier management for outsourced products. Once contract operation departments are established, a system of supplier management can be integrated in conjunction with the contractor and thus a supplier management program can be developed to manage the business relationship. Having a dedicated group to manage these operations will alleviate the problem of mismanaging the outsourcing relationships within the pharmaceutical industry. Companies such as Pfizer, Hoffmann-LaRoche and Novartis are just a few of the organizations that have embraced the contract operations outsourcing concept and have established departments dedicated to managing the relationships and all that is involved. Pharmaceutical organizations that are successfully driving down time, cost and defects from their outsourcing processes have built a strong backbone of supplier management capabilities. According to a benchmarking study conducted in February 2003, best in class for managing contract manufacturing relationships should address the following: 1. Establish a centralized corporate group with both technical and business skill sets to oversee all contract manufacturing operations; 2. Inform contract manufacturing partners of all quality related requirements and policies; 3. Develop strategic partnerships with suppliers to drive continuous quality and manufacturing improvement; 4. Maintain high level of communication with contractors. Supplier Management is much more than a process to be established by the organization. It is a relationship supported by people, technology and tools. It is a mechanism that enables organizations to have visibility and the measure the performance of both the supplier and themselves. When a sponsor effectively and efficiently implements a supplier management program, it will discover a system that drives lower costs, high operational efficiency levels and high bottom-line results. It is recommended that pharmaceutical organizations: 1. Treat contractors as a point of flexibility by pushing inventory, quality issues, operational pricing and value-added tasks back to the contractors; 2. Evaluate the organizations internal processes and structures to assure a robust supply management program is implemented and has visibility at the highest level within the organization; 3. Emphasize the relationship management component of the supply management program, which typically drives many of the metrics;

4. Manage the supply relationship by exception while placing initiatives to consistently improve through contract feedback, industry benchmarking and process reevaluation.

Future Outsourcing Trends: Some future trends of manufacturing and packaging outsourcing in the pharmaceutical industry have been identified: Outsourcing decisions will be increasingly driven by strategic imperatives and supported by total cost models/analysis; Contractors will be increasingly involved in design and have responsibility for more complex and higher level assemblies; Contractors will be increasingly involved in communicating their core competencies and provide input for making outsourcing decisions across the supply-chain; Companies will more formally and critically assess the overall outsourcing process, from decision making to implementation, to continuously improve such efforts; Everything except core competencies is a candidate for increased outsourcing; Even core competencies are candidates for increased external supplier involvement as companies develop closer relationships and alliances with key suppliers. Future trends of global outsourcing indicate that pharmaceutical organizations need to focus on successful supplier management performance strategies and programs. Organizations must be empowered to handle the strategic task of outsourcing, which involves being equipped with the right skill sets, including: relationship management, project management, change management, contract management, problem solving, negotiation skills, conflict management, the ability to manage financial and non-financial metrics, and a thorough understanding of pharmaceutical manufacturing and packaging operations. END

References 1. Greaver, F. Maurice (1999). Strategic Outsourcing: A Structured Approach to Outsourcing Decisions and Initiatives. New York, New York: AMA Publications, a division of American Management Association International. 2. Fawcett, E. Stanley (2000). The Supply Management Environment: Volume 2 of the Institute for Supply Management, Supply Management Knowledge Series. Tempe, Arizona: ISM Publications, a division of Institute for Supply Management.. 3. Joiner, Cyndi (2003). Series Article #1: Supplier Performance ManagementA Strategic Investment. Harvard Business Review

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