Outsourcing beyond the comfort zone: pharmaceutical companies can evaluate the opportunities of global outsourcing by considering the strategic approaches of other industries and of the pharmaceutical companies already outsourcing outside the United States and Europe
Pharmaceutical companies are under constant pressure to innovate, comply with a myriad of regulations, and meet the demands of quality standards--all while delivering as much profitability as possible. Challenges are escalating. Investors are accustomed to double-digit growth, which is a goal pharmaceutical companies will be hard-pressed to achieve as patents expire, blockbuster launches decline, and large customers, especially governments, step-up pricing pressures on the industry.
At the same time, compliance with stricter regulatory requirements is lengthening the time to launch a drug into the marketplace. The average number of clinical trials per new drug application has more than doubled in the past 30 years, and the average number of patients participating in clinical trials has increased two and half times during the same period. Research and development (R&D) costs also are rising. In fact, the cost of bringing a new drug to market has more than doubled in the past decade and is approaching US$1 billion (1). The pharmaceutical industry's general and administrative costs are high as well--at 28% of revenue, based on A.T. Kearney's analysis of the top 10 pharmaceutical companies' 10K submissions. Pharmaceutical general and administrative expenses, as a percentage of revenue, were two-thirds higher when compared with a broad mix of companies in highly technical, process industries, consumer goods, and retail mix. There's no quick fix, but pharmaceutical companies must control costs and increase productivity.
It's inevitable that global outsourcing will become a part of the answer as it has in other industries (see Figure 1). Financial institutions, led by GE, Citibank, Amex, and HSBC, are guiding the way. In 1999, Citibank formed e-Serve International Ltd., a business processing company based in India. The company's offerings include transaction, customer care, and technology services. Four years after being established, e-Serve performs more than 100 million transactions per year.
Other industries such as automotive (in Stage 4) and consumer products (in Stage 3) have shown substantial progress in moving along the lifecycle curve. Procter & Gamble, for example, is consolidating its administrative functions into three business service centers in Costa Rica, the United Kingdom, and the Philippines. This initiative is part of Procter & Gamble's Organization 2005 program. These three sites will provide employee services, purchasing, information technology, finance and accounting, and customer logistics. As a combination of traditional outsourcing (i.e., using an external firm rather than internal resources to provide a service) and offshoring (i.e., seeking services outside the country), global outsourcing represents an opportunity to find the most efficient and effective means of bringing drugs to market. Traditional outsourcing is not new to the pharmaceutical industry. Many companies already look outside their own walls for services in information technology, payroll, manufacturing, clinical trials, and clinical trial data management.
Until recently, however, pharmaceutical companies have been reluctant to outsource beyond the United States and Europe, in part because of concerns about intellectual property protection, demands for regulatory compliance, worries about political stability and business continuity. Given the pressures on the industry, however, the potential benefits of global outsourcing are difficult to ignore. Simply put, the industry cannot maintain the status quo. A.T. Kearney analysis indicates that if growth and pricing pressures maintain their current trajectory, by 2008 the US pharmaceutical industry will face a US$48-billion gap between investor expectations and estimated revenue (see sidebar, "Running the numbers").
Because global outsourcing can help pharmaceutical companies address cost pressures and the need for increased productivity, while also leveraging capacity and capabilities, it is inevitable that the global outsourcing trend will grow. The opportunities for pharmaceutical companies are significant: accelerated time to market and greater profitability. On the other hand, companies that wait to see how others in the industry fare may be forced into playing catch-up.
The benefits: time and money
Why push the outsourcing envelope? Although cost--cutting often is the first reason cited--and certainly a key concern--global outsourcing can yield various benefits. First, time is money, and outsourcing can save time. If companies can shorten today's long lead times for drug development by handing off tasks to third parties that can perform them more quickly because of fewer constraints or additional resources, they will find themselves in an advantageous position. For example, companies conducting clinical trials in India and China can take advantage of a large population base and a diverse pool of currently untreated patients, which are two factors that can accelerate clinical trials.
Global and domestic outsourcing can play a key role in shortening the drug development process by enabling pharmaceutical companies to hand off selected tasks, thereby freeing up resources to devote more time to additional strategic activities. Global outsourcing also can enhance the quality of and access to talent. Many firms are tapping into India's pool of scientists, who have solid capabilities and strong expertise. AstraZeneca, for example, recently built a research facility in Bangalore that focuses on tuberculosis. The company plans to invest another US$30 million during the next five years for laboratory equipment and operations costs. "Our investment here in Bangalore is definitely not based on cost, because the cost of doing research is mainly a small part of the total global research and development efforts," Sir Tom McKillop, AstraZeneca's chief executive, told India-based pharma portal pharmabiz.com. "The only reason for opting for India is the quality of scientists."
Of course, the savings are compelling. The costs of direct and indirect personnel, depreciation costs, and material are roughly 40% lower in countries such as China and India (see Figure 2). Our analysis assumes that indirect staff includes both local offshore and US corporate oversight; local offshore oversight helps lower costs.
One example is clinical trial costs. ClinTec International, a privately owned full-service contract research organization with headquarters in Germany, for example, reports that recruiting 200 patients in the United States for a one-year study would take approximately 3-6 months. ClinTec claims this time can be cut in half by recruiting patients in India. The time required for data analysis also can be significantly shorter, from 6-10 weeks in India versus nearly four months in the United States. According to the company, the estimated cost savings may reach 50-50% compared with the costs of conducting the trials in the United States. Lower costs are a result of lower wages of key personnel involved in conducting clinical trials and data monitoring (e.g., clinical research assistants, project management, clinical data management, and biostatisticians) and lower investigator grants (i.e., payments to physicians for their expertise and time in monitoring clinical-trial patients).
In addition to these savings, companies can avoid significant fixed costs and capital outlays. For instance, by partnering with a local pharmaceutical company for selected drug discovery efforts, companies can minimize capital investment associated with setting up their own R&D facilities in offshore locations. For labor-intensive activities, the low costs of labor and infrastructure abroad are more than enough to offset such added expenses as additional travel and higher telecommunications costs.
Good reasons for reluctance
Despite the opportunities, the news isn't all good. When A.T. Kearney and CFO Research Services conducted interviews with executives and professors from 13 pharmaceutical and biotechnology companies and academic institutions in Q2-Q3 2004, those surveyed expressed many misgivings about turning over complex functions to third parties overseas (2). "Pharmaceutical companies are notoriously conservative on everything they do. They do not like to give up control of anything," notes Andrew Bonfield, chief financial officer of Bristol-Myers Squibb.