EquaTerra Perspective Pharma Outsourcing Future Jun2009 3129

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The Issue: Charting a Future Course forOutsourcing in the Pharmaceutical IndustryBy: Vicki Phelan, Pharmaceutical Industry Practice Lead

Stan Lepeak, Managing Director, Global ResearchRich Pierle, Client Executive

The global pharmaceutical industry is inan accelerating state of transition. Shifting demographic trends in both western and emerging markets are driving the demand for more and better pharmaceuticals.Healthcare spending levels globally have never been higher. Yet pharmaceutical rms face a growing and daunting array of competitive, regulatory, price and operational challenges. There are growing threats to intellectual property protection and a general demonizationof pharma rms by some mainstreammedia, politicians and in uencers. Major changes to business models are needed,including more consolidation to gaingreater economies of scale and better and more ef cient ways to bring new drugs to market. Excelling at the core business of pharmaceuticals is more critical thanever. Outsourcing is playing a growing and increasingly important role in de ning next generation pharma business and operating models.

The Details

An analysis of basic demographic trends for the users ofpharmaceutical products would lead to the assumption thattimes have never been bet ter for the industry. Aging andincreasingly unhealthy populations in western markets have agrowing and urgent need for a wide range of pharmaceuticalaids and cures. Growing af uence in emerging markets iscreating large classes of prospective pharma consumers.Healthcare spending levels globally have never been higherdespite the best efforts to reign them in. Advances in drugdesign and development techniques are opening doors to newclasses and types of pharmaceutical and biotech products.

Yet the reality of the situation is more troubled for both

pharmaceutical rms and those who use their products.Pipelines for new drugs are weak in many large pharmarms. At the same time, many lucrative blockbuster drugsare coming off of patent. Regulatory scrutiny continues togrow as does the recurring threat of litigation over real orperceived drug side effects. Healthcare spending is up butis not keeping pace to support the desired levels of services,at least as de ned by the patient and consumer. Much of theworld and their governments that want more and better drugshave little interest in paying their true price and have fewqualms about pirating products. An increasingly loud and less

than well informed media, populace and politicians want toenjoy the bene ts pharmaceutical rms can deliver but at thesame time make the business of being a pharmaceutical rmuntenable (or at least less pro table). Regardless of the virtuesand motives underlying the drivers of change, the globalpharmaceutical industry is evolving toward a new operatingmodel.


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Rede ning the Pharma Operating Model

Global pharma rms are rethinking their core operating models. This is manifestedin a new and signi cant round of market consolidation via mergers and acquisitions(M&A). The goal of these efforts is to create even greater economies of scale forboth strategic and operational activities. There is the desire to capitalize on synergiesbetween existing competitors, for example by marrying a rm with a strong brandand distribution channel with another that has a stronger new drug pipeline.

Pharma M&A is nothing new but the scale occurring today is unprecedented. Thereis also greater focus than in the past on ensuring that the bene ts and synergiesprojected from M&A efforts are fully realized. While mergers have enabled pharmarms to reduce costs, for example by consolidating operations, they have alsoresulted in sprawling, costly and often duplicative back-of ce and support operations.

Melding of signi cant investments in information technology (IT), applications andsystems creates complex operating environments that require extensive care andfeeding and are often in need of rationalization. The challenge in the current roundof M&A activity is to lessen these negative side-effects while gaining the expectedcost savings.

Pharma rms are rede ning their strategies relative to diversi cation vs.specialization. This includes reassessing what work is so strategic that it leads tocompetitive differentiation and therefore must remain as internal operations (e.g.,drug design, drug branding) and what work, while still strategic, a third part ycan viably perform (e.g., drug development, clinical trials). While pharma rmsare reassessing how to best perform strategic activities, they continue to have

more interest in letting someone else perform a broader range of back-of ce andoperational services (e.g., IT, nance and accounting (F&A), human resources (HR),facilities management). These strategic changes are affecting M&A, divestiture andpartnership efforts and driving more business process and IT outsourcing (BPO/ITO).

How are Pharma Buyers Responding?

The outsourcing landscape among global pharma rms is radically different than itwas ve to ten years ago. This is the case both relative to the volume and scale ofdeals as well as what is in scope for outsourcing both in the front and back of ces.

While in the current economic environment any outsourcing effort is focusedon achieving maximum near term cost savings. From a strategic perspective,pharma buyers are focused on transforming via outsourcing how theydeliver operational services. This is in contrast to the lift and shift mentalityembraced in earlier deals, particularly ITO. The incremental costs savings werethe primary goal but a major overhaul of service delivery models and processeswas not in scope as is more often the case today.

Pharma outsourcing buyers have become more sophisticated. Out clausesin contracts, for example, are more prevalent and creative. Buyers are smarterabout pricing and understanding you get what you pay for in outsourcing.Multi-sourcing is becoming more common both as a strategy and as a result


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of simply doing more outsourcing. This creates greater access to more diverseskills but makes the outsourcing governance process more expensive and

complex.

The use of lower cost offshore resources has become commonplace bothfor back-of ce and strategic activities like R&D (research and development).The model is moving beyond simple point-to-point offshore solutions andtowards a true global sourcing model using multiple providers across multiplegeographies. This sourcing model better re ects the operating model andfootprint of global pharma rms, but it also introduces signi cant sourcingand outsourcing governance complexities. In parallel with these trends Indianservice providers have become more competitive for both BPO and ITO pharmaservices.

The strategic goals of outsourcing in the pharma industry are more than justreducing costs. The need to reduce costs, often signi cantly, is a given. Greateremphasis is now placed on redirecting highly skilled employees to more valuable andstrategic work while eliminating the lower value and commoditized work throughoutsourcing. Increasingly pharma rms are not only recognizing that internallyperforming lower value work does little to create differentiation, but also how thiswork is performed is largely irrelevant to their strategic competitiveness. There isgrowing acceptance of standardized processes, models and IT systems to supportand perform back-of ce work and a recognition that maintaining highly customizedoperations, even if at reduced costs, does little to support strategic goals.

The result is that the pace of pharma outsourcing continues to accelerate. Figure1 illustrates outsourcing uptake among major pharma rms over the past tenyears in the ITO process areas of infrastructure and application development andmaintenance (ADM). The gure illustrates both the growth of ITO in the pharmamarket and the expansion of scope to more often include ADM.

Pharmaceutical ITO Timeline by Buyer

IT (ADM)

1999 2000

AZAstella

2001

BayerAllergan

J&J

J&J

2002

BIAZ

GSK

2003

DSMAkso

NobelAstellas

AZ

BMS

2004

DSMLillyDSMGSK

Pfizer

Pfizer

2005

MerckJ&J

WyethNovartis

NovartisCatelant

2006

AZBMS

PfizerNovartisOrganonCatalent

MerckRocheSanofi

ScheringShire

PfizerJ&J

2007

AmgenSchwarzpharma

UCB

AZAmgen

J&J

2008 2009

Figure 1


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Pharma outsourcing buyers continue to expand the functional and process areas in scope for outsourcing beyond ITO. TodayF&A, HR, source to pay (S2P), real estate and facilities management services are being outsourced. Even more strategic activities

like clinical data management (CDM), sales force analytics and research are targets for outsourcing to third-party providers.Figure 2 illustrates the level of outsourcing across 10 major functional areas in 20 of the industrys top global and regionalpharma rms. Sales force analytics is the function most frequently (at least partially) outsourced while the greatest scope dealsare occurring in ITO, followed by F&A and CDM. There have also been multiple large, global Human Resources Outsourcing (HRO)deals in the pharma market segment. This level and depth of investments exemplify the transition of pharma rms from verticallyintegrated to horizontally specialized in their pursuit of competitive differentiation.

Pharmaceutical Sourcing Landscape by Function and Buyer

RevenueRank Company IT F&A S2P OTC HR CDM

ResearchChemistry

Real EstateMgt Legal

SalesforceAnalytics

1 P zer

2 GlaxoSmithKline

3 Sano -Aventis

4 AstraZeneca

5 Merck

6 Novartis

7 Johnson & Johnson

8 Roche

9 Eli Lilly & Co.

10 Wyeth

11 Bristol-Myers Squibb

12 Abbott Laboratories

13 Schering-Plough

14 Bayer Schering

15 Boehringer Ingelheim16 Takeda

17 Astellas

18 Daiichi-Sankyo

19 Eisai

20 UCB Group

Functions Sourced

NoneUnlikely orUnknown

Evaluating /In Process Some Most

Figure 2


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How are Outsourcing Service Providers Responding?

The growth in the level and scope of pharma buyer outsourcing demand has beenfacilitated by the growth in depth and breadth of service provider capabilities.Outsourcing demand cannot successfully grow without the availability of qualitysupply. This is manifested in the growth and expansion of capabilities among legacymultinational ITO providers and the penetration into the market by India-basedservices providers rst in ADM and more recently in ITO and BPO. There are alsomany specialist regional and India-based providers with offerings in emerging areassuch as sales force analytics, regulatory, rebate processing and research.

The build it and they will come theory is a bit like the chicken and the egg situation.The providers must be careful not to invest in a capability that is way ahead of itstime yet they must be forward thinking enough to anticipate the market direction.

Conversely, pharma buyers may have strategies that include outsourcing a capabilitynot traditionally considered core but the supplier market is not yet positioned orready for it. The balance is not yet perfect but the service providers are investingheavily in new BPO market segments to meet buyer demand.

The pharma industry is actively targeted by service providers offering emerging BPOand knowledge process outsourcing (KPO) services such as analytics and R&D. Thisis not surprising given the knowledge-intensive nature of the core business of theindustry making it more ripe for knowledge-intensive services. Both multinationalBPO providers as well as India-based service providers who initially entered themarket through IT and ITO services are now expanding their BPO and KPO offerings. Itis critical that both buyers and service providers understand the buyers risk tolerance

when venturing into these new BPO and KPO areas.

Providers are competing aggressively for new business and for experienced staff tobuild out their offerings. India-based rms in particular have been hiring western-based staff with pharma industry experience to lead and support the growth of theirofferings. The India-based service providers are typically more aggressive about whatservices they seek to deliver remotely as they recognize the need to have a strongerlocal delivery presence for select BPO and KPO services.

Last year EquaTerra surveyed pharma outsourcing service providers on the maturityof their service offerings in several BPO and KPO areas. The research also probedproviders future plans in these market segments. The research analyzes key

investment areas being pursued by providers, the level of buyer uptake in these areasand the success buyers are having in achieving the goals sought in their outsourcingefforts. The full results from this research are available in the EquaTerra Perspectivepaper Emerging BPO and KPO Trends in the Pharmaceutical Industry available fordownload at http://www.equaterra.com/fw/main/Emerging-BPO-and-LPO-Trends-in-the-Pharmaceutical-Industry-1069C513.html?LayoutID=32 .
http://www.equaterra.com/fw/main/Emerging-BPO-and-LPO-Trends-in-the-Pharmaceutical-Industry-1069C513.html?LayoutID=32http://www.equaterra.com/fw/main/Emerging-BPO-and-LPO-Trends-in-the-Pharmaceutical-Industry-1069C513.html?LayoutID=32http://www.equaterra.com/fw/main/Emerging-BPO-and-LPO-Trends-in-the-Pharmaceutical-Industry-1069C513.html?LayoutID=32http://www.equaterra.com/fw/main/Emerging-BPO-and-LPO-Trends-in-the-Pharmaceutical-Industry-1069C513.html?LayoutID=32


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The Advisor Perspective Critical Points to Consider

While many pharma buyers have had success with outsourcing and continue toexpand efforts, doing so successfully remains challenging. There are operationaldif culties related to successfully sourcing new deals and tting them into theexisting portfolio. Outsourcing governance challenges grow with the size andbreadth of the portfolio. The service provider landscape is uid and keeping trackof the best providers for different tasks is dif cult. There are also a broad range ofadditional challenges to developing and executing a sourcing strategy in an industryin ux and during a period of global economic turmoil. Current conditions make iteven more dif cult to de ne and execute a long-term strategy.

There are important directional trends in the global sourcing market and pharmaindustry that EquaTerra recommends all outsourcing buyers and users account for in

their sourcing strategy.

The ongoing globalization of business and IT services market will continuelargely unabated. Protection policies will have little tangible impact on globalsourcing in the long run, especially for global rms like many in the pharmaindustry. On the plus side, providers will get better at designing, optimizingand delivering a broader range of services globally in a more integrated andcoordinated manner.

Market consolidation within the pharma industry and between pharma andother life science industry segments will continue to accelerate. Relative toglobal sourcing this creates both challenges and opportunities to expandefforts, rationalize, streamline and improve the ef ciency of existingarrangements. Buyers can take advantage of change efforts to overhaul servicedelivery models to take greater advantage of global sourcing opportunities.

Pharma rms have great opportunities via divestitures and spin-offs to recreatetheir service delivery models and operations. New opportunities exist tomaximize the use of third party specialists to manage and deliver these servicesand enable the new corporate entity to focus more intently on differentiatingactivities over back-of ce or lower value-add operations.

Cost reduction programs will become more rigorous and cut closer to thebone for at least the next 12-24 months. Pharma rms operate in a cyclicalmarket, though less so than some other industries. Pharma rms should notdelay, however, rationalizing operating and service delivery models to improvemargins. EquaTerra sees many pharmaceuticals using these dif cult andrecessionary times as the impetus to make broad scale changes that arguablyshould have been undertaken several years ago.


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Creative alliances and signi cant outsourcing relationships will more often arisein functional areas previously handled primarily as internal operations. Buyers

need to understand their options in these new areas, including best practicebusiness case models and the make-up of the supporting service providerlandscape. These areas include the following.

Real estate and facilities management

Regulatory compliance

Research and development

Legal

All outsourcing buyers, including those in the pharma sector, must improve

their skills and increase the emphasis on becoming better at outsourcinggovernance. As more services are performed by third parties the required skillsto manage this service chain must become a core competency just like thoseused to manage drug development, manufacturing and distribution supplychains. Improved techniques include the following:

Managing multi-sourcing and multi-provider relationships and engagements

Managing sets of third-party service relationships more as a portfolio andless as individual engagements

Better de ned and standardized outsourcing governance processes and

modelsGreater use of specialized software tools to automate and supportoutsourcing governance efforts

Pharma rms must explore and better understand how they can use ITO andBPO efforts as the means to rationalize and improve their global enterprisesystems environments. These enterprise software systems are the backbonefor global operations. This does not mean that buyers need to own and directlymanage all aspects of operations. This becomes more important as upgraderequirements become more expensive and onerous and more alternativesoftware models (e.g., software as a service, cloud computing, social

networking) that merit considerations and possible adoption come to market.


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Copyright EquaTerra 2008. All rights reserved. The prior written permission of EquaTerra is required to reproduce all or any part of thisdocument, in any form whether physical or electronic, for any purpose. 3129_062009.

About EquaTerra

EquaTerra sourcing advisors help clients achievesustainable value in their IT and business processes.Our advisors average more than 20 years ofindustry experience and have supported over 2000transformation and outsourcing projects across morethan 60 countries. Supporting clients throughoutthe Americas, Europe, and Asia Paci c, we have deepfunctional knowledge in Finance and Accounting,HR, IT, Procurement and other critical businessprocesses. EquaTerra helps clients achieve signi cantcost savings and process improvement with internaltransformation, shared services and outsourcingsolutions.

www.equaterra.com

Contact Us

If you would like to know more about EquaTerra, please contact us.

If you have questions about this report or would like to learn moreabout how EquaTerra can help your organization address the pointsand opportunities discussed, please contact Vicki Phelan orStan Lepeak.

Vicki Phelan, Pharmaceutical Industry Practice Lead,

[email protected], +1 609 304 1030

Stan Lepeak, Managing Director, Global Research,[email protected], +1 203 458 0677

Rich Pierle, Client [email protected], +1 908 284 9535

For additional information on EquaTerra, please contactLee Ann Moore, [email protected], +1 713 669 9292.

For all our locations, please visit www.equaterra.com/locations.

Europe/Asia Paci c +44 (0) 845 838 7500 [email protected]

Americas+1 713 470 9812 [email protected]

Conclusion

The global pharmaceutical industry is facing dif cult times. Major changes to existingoperating models will accelerate. Firms responses to these challenges range fromloss of intellectual property rights, new global competition, and bloated legacyoperating models to new national healthcare models that challenge core industryoperating principles. Improved ways of doing both the strategic and operational workof pharma are required. Outsourcing efforts to date in the pharmaceutical industryhave been largely successful at reducing costs and shifting focus away from lowervalue added activities. These trends will not only continue but will accelerate andbroaden in scope.

For more information on our Pharmaceutical services or to contact an expert, please see ourWebsite at: http://www.equaterra.com/fw/main/Pharmaceutical-955.html
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EquaTerra Perspective Pharma Outsourcing Future Jun2009 3129