Managing Risk in Pharmaceutical Global Supply Chain Outsourcing: Applying Analytic Hierarchy Process Model

Because of the intense pressure to contain R&D costs, pharmaceuticals firms are increasingly outsourcing their supply chain operations. Global supply chain outsourcing can be viewed as a strategic competitive weapon rather than cost savings initiative because it can offer flexibility in production, satisfy ultimate consumers’ growing demands, reduce fixed costs, and enhance positional advantage. Thus, for the pharmaceutical firms, global supply chain outsourcing has become a competitive requirement for ameliorating performance and profit margin. It allows allow firms to leverage their core skills and resources well beyond levels available with other strategies. Well executed global supply chain outsourcing strategies can enhance returns on capital, reduce risk, improve flexibility, and make firms more responsive to their customers and shareholders’ requirements. Although the attractive benefits associated with global outsourcing have been acknowledged widely, much of the inherent risks tend to be overlooked. Acknowledged pharmaceutical supply chain outsourcing risks include regulatory risk, operational risks, technical risk, and corporate social responsibility risk. Supply chain risk management strategies that can be employed to tame a firm’s exposure to supply chain outsourcing risk are risk avoidance, reduction (mitigation), transfer, and acceptance (retention). INTRODUCTION To flourish and survive in today's competitive global marketplace, firms are increasingly focusing on their core competencies and turning towards outsource functions in which they possess no expertise to maintain effective cost structures and to improve their top and bottom lines. In today’s hypercompetitive global marketplace no one firm can go it alone and become successful in search of market opportunities in near real-time and cost-effective fashion because of lack of key talents and knowledge experience bases (Conklin, 1994). Due to few blockbuster drugs in the pipeline chain and competition from generics firms, the pharmaceutical firms are increasingly scrutinizing their operations to improve shareholders’ value and profit margins (Snee, 2006). In ASBBS Annual Conference: Las Vegas February 2009 Proceedings of ASBBS Volume 16 Number 1 particular, the practice of pharmaceutical outsourcing has become more than ever a viable strategic business option to gain competitive advantage. The most commonly cited reasons for the increase in pharmaceutical outsourcing include cost savings associated with cheaper labor and infrastructure, reduced burden on the firm to research and discover drugs, the shift from a fixed cost to a variable cost model and the ability to acquire new technology and knowledge via the utilization of specialized external providers. Indeed, maintaining internal pharmaceutical researchers in-house is no longer required and relevant nowadays. The costs of producing drugs can impose daunting pressures on a firm’s resources. The pharmaceutical industry has seen its R&D productivity decline significantly (Dimasi et al., 2003, Grabowski and Vernon, 2000) and the traditional generation of new chemically based small molecules dwindling (Backman and Segrestin). Driven by the need to ameliorate R&D productivity and efficiency and to have access to untapped markets, global pharmaceutical firms have increasingly outsourced operations to contract research organizations (CROs) in India and China. The nature of outsourcing areas include information technology (IT) and IT support, human resource, R&D, procurement and logistics. Arguably, pharmaceutical firms are turning to supply chain outsourcing as a way to improve product pipeline and gain strategic competitive advantage. Pharmaceutical global outsourcing has become a viable and a lucrative business strategy that is enabling firms to transfer non-core activities to external partners in order to restructure their distribution networks, leverage resources, spread risks, focus on issues imperative to survival, competitive advantage, and future growth (Sink and Langley, 1997, Wang and Regan, 2003). Thus, R&D costs, regulatory pressure, patent expiry, declining blockbuster pipeline chain, among others have caused pharmaceutical manufacturers to focus on their core competencies by outsourcing supply chain non-core activities to contract manufacturing organizations (CMOs) and/or CROs. Firms’ increasing focus on core competencies and the need to reduce cost are motivating them to turn to global outsourcing. This trend towards global outsourcing relationships has been strong in various types of firms and in different parts of the supply chain (Fill and Visser, 2000). It has been recognized as one of the eight most prominent factors playing a key role in the offing for superior supply chain performance (Carter and Narasimhan, 1996). And superior supply chain is one that enables a firm to optimize the value of internal activities and in turn creating collaborative partnerships that can lead to high value external activities (Lakhal et al., 2001). Christopher (1999) noted that it is only those firms that can leverage the collective strengths and competencies of network partners will be able to achieve a faster responsiveness to changing global marketplace requirements. Although outsourcing started by transferring non-core activities traditionally executed in-house to CMOs, there seem to be a growing interest towards outsourcing of fixed assets and/or the whole manufacturing process (Markeset and Kumar, 2004). For example, Calaf (1995) contends that increasing number of firms are opting to outsource many of their manufacturing activities to other firms have manufacturing knowledge base. Although outsourcing to contract organizations can have both positive and negative impacts on key aspects of pharmaceutical manufacturing supply chain, “one positive effect is that the manufacturer’s supply chain agility is increased” (Mason, et al, 2002). Lindholm and Suomala (2004) assert that the goal of outsourcing is to attain optimal performance within a firm and a supply chain. This paper discusses the pharmaceutical global supply chain outsourcing trends, drivers, and functions (areas). It also examines emerging risks in pharmaceutical global supply chain outsourcing. Specifically, it proposes measures to manage pharmaceutical global supply chain outsourcing using Analytic Hierarchy Process model. Outsourcing can allow firms to leverage their core skills and resources well beyond levels available with other strategies. Core competencies and well executed outsourcing strategies can enhance returns on capital, reduce ASBBS Annual Conference: Las Vegas February 2009 Proceedings of ASBBS Volume 16 Number 1 risk, improve flexibility, and make firms more responsive to their customers and shareholders’ requirements. PHARMACEUTICAL GLOBAL SUPPLY CHAIN OUTSOURCING TRENDS After many years of recorded growth and profitability, the pharmaceutical industry is challenging time. As a result, to remain viable they are looking toward new business model to improve their pharmaceutical supply chains and contain costs. And the new business model to accomplish that is global supply chain outsourcing. For example, estimate has it that the U.S. market for outsourced pharmaceutical manufacturing is expanding at the rate of 10 to 12% annually. The Pharmaceutical firms will continue to drive much of this growth as they outsource large number of products and services http://www.kaloramainformation.com/Pharmaceutical-OutsourcingOpportunities-) to emerging economies in Asia. For example, the pharmaceutical industry is increasingly outsourcing its R&D to Asia in desperation to tame the rising cost. Indeed, global supply chain outsourcing represents one of the acknowledged organizational and industry structure shifts of the 21 century for the pharmaceutical industry. The pharmaceutical and biotechnology industry is outsourcing at almost every phase of the supply chain value stream. Developing strategic global supply chain outsourcing relationships with contract manufacturing partners can afford the pharmaceutical industry the opportunity to focus on core competencies, have access to specialized expertise, and enhance cost-saving benefits that can contribute to customer and shareholder values. Because of the cost of drug development, regulatory, pricing, and changing competitive environment, the pharmaceutical firms are turning to global outsourcing strategy to secure and improve profit margin. PHARMACEUTICAL GLOBAL SUPPLY CHAIN OUTSOURCING DRIVERS Pharmaceutical outsourcing trends and drivers include time to market, cost advantage, risk management, and strategic focus (PricewaterhouseCoopers LLP, 2006). The premier factors driving growth of pharmaceutical global outsourcing trend include competitive global marketplace, enhancing greater productivity flexibility, attaining a global manufacturing presence, expanding capacity, enhancing product quality achieved through costs reduction and better focus on core competencies, curtailing investments in capital assets, and improved asset utilization. Global supply chains outsourcing enables pharmaceutical firms to take advantage of global relative advantages, as well as increase product variety. The increasingly global nature of the pharmaceutical/biotech industry endorses outsourcing, as most companies tend to exploit the market by gaining competitive advantage. Pharmaceutical firms have recognized that possessing the entire skill range required within an industry is not feasible. As flexibility has become critically vital within the industry, firms are realizing that concentrating on core competencies is an efficient and effective way to create optimum value. Indeed the expansion in the pharmaceutical contract service industry in recent years has contributed to a significant boost in the number of services and functions available for outsourcing to contract manufacturing and R&D firms. In the recent years, the pharmaceutical firms have aggressively been reassessing their financial position and worst engaged in mergers and acquisition because of the mounting cost pressures and the need to survive. The critical factors driving the pharmaceutical industry to seek global outsourcing are the search for efficiencies in the drug development cycle, extending a company’s capacity, consolidation of the pharmaceutical industry, access to specific therapeutic expertise and globalization of the market within USA, Europe and Asia (Srivastava, 2002), and exploit new individualized drugs. ASBBS Annual Conference: Las Vegas February 2009 Proceedings of ASBBS Volume 16 Number 1 ADVANTAGES/DISADVANTAGES PHARMACEUTICAL GLOBAL SUPPLY CHAIN OUTSOURCING Advantages and disadvantages associated with pharmaceutical global supply chain outsourcing to CROs (Piachaud, 2002) are reported in Table 2. Further, Datamonitor (2006) suggested that the advantages linked to pharmaceutical global supply chain outsourcing are 1) opportunity to drive productivity and efficiencies across a variety of business functions, 2) boosting long-term R&D productivity, 3) financial benefits, 4) shortening drug discovery stage, 5) access to additional drug discovery expertise and technologies, 6) flexibility, and 7) focusing free-up resources for core competencies, while the disadvantages include 1) level of returns on compounds generated through outsourcing agreements tend to be lower than in-house, 2) reduced opportunity to develop internal expertise, 3) loss of control and issue of confidentiality of proprietary information. Table 2: Advantages and Disadvantages of Pharmaceutical Outsourcing to CROs Perceived Outsourcing Advantages Perceived Outsourcing Disadvantages Obtain greater flexibility Dependence on the supplier Buy in specialized knowledge and skills Lack of shared vision and objectives Facilitate the rapid exploitation of technology Loss of control over suppliers Gain a window on a new technologies Loss of critical skills Freedom to concentrate on core functions Problems of evaluating supplier performance Spread risks Need for a new management mind set Reduce costs Problems of monitoring supplier performance Increase time to market Class of culture Source: Piachaud, B. S. (2002). Outsourcing in the Pharmaceutical Manufacturing Process: an Examination of the CRO Experience.” Technovation, 22(2), pp. 81-90. Persson and Virum (2001) suggest that the potential economic benefits associated with outsourcing include reducing operating costs; exchanging fixed costs with variable costs; elimination of infrastructure investments; access to world-class processes, products, services or technology; better cash-flow; improved ability to sense and respond real-time to changes business environments; sharing risk; and access to resources not available in-house. The pharmaceutical industry is passing through a very challenging time. Successful pharmaceutical firms have realized the imperative of leveraging their resources. As a result, they are increasingly relying upon the wealth of expertise offered by specialist external sources, including Clinical CROs. This transition to a more integrated approach to conducting pharmaceutical R&D has however led to a change in practice within the traditional working environment of the pharmaceutical sector. Although pharmaceutical manufacturers have identified a number of advantages and disadvantages as a result of working with these external agents, the potential for enhancing the partnership process still exists. The factors driving the use of CROs include converting fixed costs into variable costs, reduction in employees, accelerate speed to market, eliminates unprofitable projects, lack of capacity, global drug development, access to knowledge and skills, and access to technology. PHARMACEUTICAL GLOBAL SUPPLY CHAIN OUTSOURCING RISKS An increasing numbers of pharmaceutical firms are realizing the potential economic advantages of outsourcing their supply chain non-core activities to external partners. Besides the advantages of outsourcing at the strategic, financial, organizational, and operational levels, there are a number of outsourcing risks which can greatly affect the quality of the relationships (Salma et al. 2007). Wang and Regan (2003) and Eyefortransport (2005) reported that outsourcing risks ASBBS Annual Conference: Las Vegas February 2009 Proceedings of ASBBS Volume 16 Number 1 include potential inefficient management; latent information asymmetry; loss of logistics innovative capacity; hidden costs; dependence on the third party logistics (3PL) providers; loss of control over the 3PL providers; problems of evaluating and monitoring 3PL provider performance; and incompatibility of participating firms’ cultures. Also, pharmaceutical outsourcing problems and risks include transaction costs; increased monitoring costs; loss of direct control over product launch; loss of internal competency and capacity; possible loss of key intellectual property; potential after-market competition; increased legal compliance and reputation costs. As pharmaceuticals outsourcing continue to grow, risks associated with it are growing as well. Some of these risks include error that can lead to FDA disapproval, long lead time, satisfying regulatory compliance, meeting the demands of Sarbanes-Oxley Act, maintaining proprietary confidentiality.As the pharmaceutical industry supply-chain strategies evolve, managing the associated risks in global outsourcing has assumed greater dimension. Because discovery and development of new pharmaceuticals involve more risks and expensive, leading pharmaceutical MNEs are entering into risk-sharing outsourcing partnerships in order to minimize operation risks by sharing management and financial responsibilities. Through appropriate risk management, outsourcing can help firms to expand their R&D pipelines and provide a greater opportunity for a drug to ultimately reach launch phase (PricewaterhouseCoopers LLP, 2006). There are a variety of factors, both internal and external, which in combination make it important for organizations to perform a structured and disciplined approach to managing and mitigating risk. Indeed, the constant changing and evolution of markets, including rivals, emerging technologies, more than ever changing customer requirements, compression of response times, and the strategic use of global outsourcing add to risks faced by organizations. Although risk management is an issue of great importance in global outsourcing due to the demands of supply chain strategies, it has received limited attention from pharmaceutical firms engaged in outsourcing relationships. Arguably, given the array of risks associated with supply chain logistics outsourcing, it is imperative that the pharmaceutical industry embrace risk management. Global supply chain outsourcing has increasingly become a strategic option for organizations seeking to increase shareholder value, reduce costs, business transformation, improve operations, overcome lack of internal capabilities, keep up with competitors, gain competitive advantage, improve capabilities, increase sales, improve service, reduce inventory, increase inventory velocity and turns, mitigate capital investment, improve cash flow, turn fixed costs into variable costs and other benefits, both tangible and intangible (Graig, 2003). As the pharmaceutical industry supply-chain strategies evolve, managing the associated risks in global outsourcing has assumed greater dimension. “Developing new drugs carries more risks and is costlier than ever. Many leading pharmaceutical companies are entering into risk-sharing outsourcing partnerships to lower their operation risks by sharing management and financial responsibilities. Through proper risk management, outsourcing enables companies to expand their R&D pipelines and provide a greater chance for a product to ultimately reach launch, thereby lowering overall business risks” (PricewaterhouseCoopers LLP, 2006). The global outsourcing risks include proprietary confidentiality and intellectual property, technical knowledge, resource availability, capacity, production risks, firm volatility, and management challenges. To achieve successful outsourcing relationships, pharmaceutical firms must have risk mitigation measures in place. For the present study the pharmaceutical outsourcing risks considered include regulatory risk, business risk, technical risk, and intellectual property risk. ASBBS Annual Conference: Las Vegas February 2009 Proceedings of ASBBS Volume 16 Number 1 RESEARCH METHODOLOGY A decision-making environment can entail multiple and in some cases conflicting objectives or criteria called multi-criteria decision making (MCDM) (Hwang and Yoon, 1981). Evaluation and management of pharmaceutical supply chain outsourcing risk represents a typical MCDM problem that entails multiple criteria that can be both qualitative and quantitative. An example of MCDM selected to model risk management in pharmaceutical supply chain outsourcing is AHP developed by Saaty (1980). It is selected because it allows decision-makers to model a complex problem in a hierarchical structure portraying the relationships of the overall goal, criteria (objectives), sub-criteria (sub-objectives), and alternatives. Although the positive attributes associated with AHP has been widely reported in the literature, there has been a small number of descending voices as to its theoretical basis. For example, Belton and Gear (1986) and Dyer and Wendel (1985) argue that AHP lacks theoretical basis. Watson and Freeling (1982) contend that AHP in order to elicit the weights of the criteria by way of a ratio scale, it asks decision-makers useless or meaningless questions such as which of these two criteria is more important for the goal and how much more. However, in defense of Saaty’s AHP, based on the theoretical research of Harker and Vargas (1987) and Perez (1995), respectively, proved that the criticisms against AHP method was not valid. They argued that AHP is indeed based on a firm theoretical ground. As a result, its application has been popularized in many fields. Research that have used AHP include supplier selection (Lee et al., 2001); project selection and management (Liberatore, 1987; Al-Harbi, 2001), international business management (Atthirawong and MacCarthy, 2005), operations and logistics/supply chain management (Enyinda, 2008; Min, 1992), marketing (Dyer and Forman, 1992), pharmaceutical marketing and management (Ross and Nydick, 1994), and accounting (Apostolou and Hassell, 1993). Following Saaty and Al-Harbi (2001), hierarchy structure modeling of risk management in pharmaceutical supply chain outsourcing shown in Figure 1 can be achieved as follows. 1. Define an unstructured problem and determine the overall goal. The overall goal is to manage risk in pharmaceutical supply chain outsourcing. 2. Build the hierarchy from the top through the intermediate levels to the lowest level which usually contains the list of alternatives. The major decision criteria occupy the second level of the hierarchy, while the sub-criteria occupy the third level of the hierarchy. The decision maker defines the criteria that will be used to judge the alternative policy options. The defined decision criteria are regulatory risk; business risk; technical risk; and intellectual property risk. The alternative policy options proposed to manage the pharmaceutical supply chain outsourcing risk are risk reduction, risk acceptance, risk avoidance, and risk transfer. The factor with the maximum local priority is selected from each category to represent the category and the relative priorities of the scaling factors computed. The derived priorities are used for final rating of the alternative policy options and selecting the most important and satisfactory policy option. ASBBS Annual Conference: Las Vegas February 2009 Proceedings of ASBBS Volume 16 Number 1 Figure 1. Hierarchy Structure of Pharmaceutical Supply Chain Outsourcing Risks Managing Pharmaceutical Supply Chain Outsourcing Risk Criterion 1: Criterion 2: Criterion 3: Criterion 4: Intellectual Property Risk Regulatory Risk Business Risk Technical Risk Policy Option 1: Policy Option 2: Policy Option 3: Policy Option 4 Reduce risk Accept risk Avoid risk Transfer risk 3. Construction of pairwise comparison matrix. Build a set of pairwise comparison matrices for each level of the hierarchy and then conduct all the pairwise comparisons. The pairwise comparison matrix A, where element aij of the matrix is the relative importance of i factor with respect to j factor, can be determined as follows: