This article is part of the 2014 compendium,
Finding Opportunity in Uncertainty. The supply chain performance of generic drug (Gx) companies stands out compared with that of its Big Pharma, non-Gx peers. Despite their much more complex product portfolio, Gx companies’ costs and inventory are much lower. Challenges, however, continue to arise in this critical sector that provides the majority of medicine to patients in need. Not only do customers often expect 99 plus percent service levels within 24 to 48 hours, but supply reliability is also becoming more tenuous as once local supply chains now extend around the world. To achieve high service standards across a global footprint, leading Gx companies have found that agility and integration along the supply chain are essential to improvement programs. We highlight the choices of leading Gx companies as well as those of fast-moving consumer goods (FMCG) companies (a sector that provides a model for continued improvement) to demonstrate the importance of agility and integration. Other hallmark features include responsiveness and stability, as well as excellence around tenders, complexity management, and long-term planning.
Supply chain leaders of generics (Gx) pharmacos deserve credit for their effectiveness in meeting the needs of the rapidly growing Gx market. Generics market share in prescription drugs has grown from 23 percent in 2007 to 27 percent in 2012, and is expected to reach 38 percent by 2020. Compared with some big originator (Rx) peers, Gx manufacturers can have ten times the number of SKUs in a marketplace and still maintain inventory levels some 25 percent lower. Our POBOS benchmarking shows that a median Gx manufacturer has 160 days of inventory on hand, compared with 210 days for non-Gx manufacturers. This is partially because Gx companies have a higher outsourcing share of API and also because Gx companies have a more responsive supply chain. Additionally, the Gx manufacturers are able to produce at a conversion cost that is 40 percent lower than big pharma sites.
That is not to say, however, that there’s no room for improvement, particularly in areas of stability and service. As a comparison, we can look at fast-moving consumer goods (FMCG) companies. These companies—food, beverage, apparel, personal electronics, and personal care—struggle with the same factors of intense competition, changing product mixes and presentations, multiple market demands, and an extremely diversified portfolio. However, the average consumer goods company operates with one-third to one-fifth of the inventory of Gx companies, and forecast accuracy is ten percentage points higher. With respect to service levels, FMCGs are comparable to the Gx average, but top-quartile FMCG companies still perform at 98.6 percent service level. To put it simply, the FMCG supply chain appears to be efficiently firing on all cylinders.
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In this chapter, we will look at what leading Gx and FMCG companies are doing to drive holistic improvements across their complex supply chains.
How to improve Gx supply chain: five key lessons
Given the nature of the market and its challenging environment, Gx companies are often in firefighting mode when managing their supply chains. Even though this might temporarily deliver what the company wants, the supply chain is not stable and cannot deliver sustainable results when it is facing large challenges. Therefore, Gx companies should focus on building the structural capabilities that can help them succeed over the long term. Below, we discuss five fundamental challenges that Gx companies are facing in their supply chain and how leaders in Gx companies and other industries are addressing them.
Making the supply chain more responsive
Gx companies need to handle volatile demands and supplies driven by internal and external factors. While patient demand is often stable for on-market products, competitor stockouts, distributor order patterns, tenders, and erratic buying and rebate patterns create volatility that manufacturers must manage. New-product launches create their own source of volatility for manufacturers that encounter uncertainty in timing, markets, and order sizes. From the supply side, Gx companies struggle with more complex manufacturing and quality issues driven by rushed development, greater on-site complexity, and often tighter resource constraints than those of innovators.
To be more responsive, supply chain leaders must do the following:
Ensure end-to-end visibility enabled by IT system: Many of the FMCG companies not only have visibility of demand-and-supply information but also have real-time information on what has been changed (for example, large demand changes, large new confirmed orders, and manufacturing delays and misses). This information is understood and seen by all parties: markets, supply chain, and sites. Establishing such visibility does not mean relying on a full enterprise resource planning (ERP) integration, which can easily take more than three years and tens of millions of dollars. Some leaders choose user-friendly interface tools that bring transparency to performance and enable routine decisions without the burden of ERP implementation. Establish a responsive and proactive cross-functional planning process to react to demand-and-supply changes: In order to be responsive and proactive, the supply chain first needs to understand and validate forecast and demand changes and their impact to operations. (This is enabled by the end-to-end visibility discussed above.) The supply chain then needs to have a rigorous planning process that enables cross-functional team members to make quick decisions based on a common business objective. Finally, the team always needs to set aside time to understand the root causes of service failures and supply disruption, and develop corrective actions to reduce the occurrence of these exceptions. A large Gx manufacturer used the “control tower” approach to establish a well-defined daily and weekly planning process that addresses the three areas mentioned above. Within four months of implementation, the company had increased the service level from the high 80s to mid 90s. Exhibit 2 shows how some FMCG companies have taken cross-functional planning across the business, under a central supply chain management (SCM) approach.
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McKinsey_Website_Accessibility@mckinsey.com Invest in postponement strategies: Gx companies need to actively leverage postponement to manage the complexity and volatility of their market. Regional supply hubs that at minimum do the packaging (or, potentially serve as regional hubs for third-party suppliers and retesting) can help simultaneously create short order lead times for the given region or market as well as decouple bulk production from market demand, thereby enabling production to focus on formulation. A significant majority of EU pharmaceutical manufacturers have adopted postponement strategies. This practice pushes the complexity as close to the end of production as practical—reducing the complexity associated with small-batch formulation in favor of small-batch packaging. A recent study of more than two dozen pharma supply chain leaders showed that about 23 percent of volume was routed through a postponement strategy. In 82 percent of cases, the manufacturers decoupled bulk and late-stage packaging, and in 68 percent they postponed labeling in order to facilitate subsequent country-specific labeling. By pushing the complexity close to customers, the upstream processes are vastly simplified. Work with customers to proactively shape demand and jointly manage demand shocks: For most of the pharma industry’s on-market products, end customer consumption is very stable. Much of the volatility is introduced by the different channel tiers. Therefore, to effectively manage external volatility, leading Gx companies are working with large distributors, wholesalers, and retailers to jointly manage and shape demand as well as manage for demand shocks. One large Gx manufacturer has visibility of inventory position at its large distributors and retailers in the United States. The company works with these large customers on a weekly basis to mitigate demand shocks and supply risk. For example, when current inventory cannot cover next month’s forecast, the company will automatically trigger an allocation process with predefined rules based on factors such as profitability, strategic relationship, importance of the customers, and impact to end patients. Customer service teams will actively communicate (for example, expected restocking dates) and manage stock level with customers when the allocation process starts. In addition to the mitigation process, the company also proactively shapes the demand with its key customers. For example, when it sees an unusually large order from the customer that has sufficient inventory, the company will reach out to the customers to understand the drivers of the orders and discuss how to smooth out the orders without impacting the supply to end customers. Monthly collaboration planning meetings also are held with key customers to share and compare forecast information. If there is a large gap between the forecasts, the company will work with the customers to understand the drivers of the gap and also determine the actions to close or reduce the gaps. By actively mitigating and shaping the demand with customers, the company can significantly reduce the “bullwhip” before it hits the manufacturing sites. Creating stable and reliable manufacturing in a highly volatile environment Many Gx companies are facing a vicious cycle in their supply chain: the commercial organization makes frequent forecast changes right up to the last minute in order to react to market changes. This in turn creates corresponding last-minute changes to the production schedule. As a consequence, manufacturing is often caught in a bind. On the one hand, it must manage frequent manufacturing and quality issues to sustain internal product and process robustness; while on the other hand, it needs to handle frequent schedule changes. As a result, manufacturing struggles to provide reliable supply to the markets. Market forecasters then lose confidence in supply and will make further changes to forecasts to try to protect the supply (for example, “If I ask for 50, I will get 40; therefore, in order to get 50, I will ask for 60”). Manufacturing will start to second-guess the forecast since they also do not trust it. Thus, the cycle continues. To break this vicious cycle, supply chain needs to work with commercial, manufacturing, and other stakeholders to provide stabilized plans to manufacturing and reliable supply to commercial organizations.
To facilitate stability, supply chain leaders must do the following:
Find the right balance between stability and agility in the supply chain: To achieve the right balance, leaders must have clear segmentation of products and tailor the planning strategy accordingly. For example, a large pharmaco has four product segments: large-volume products, small-volume products that can be championed with the large-volume products, other small-volume but stable products, and very small-volume and volatile products. For large-volume products, the company establishes a stable, cyclic planning approach with fixed production frequency and frozen lead time. It then “piggybacks” the second group of products with large-volume products through champions (although these products have lower production frequency and are not necessarily produced each time the large-volume products are produced). For other small but stable products, it slots in flexibility based on the order or inventory situations. Finally, for very small-volume and volatile products, it reviews the needs of every production period and triggers a production if inventory falls below a certain ratio. When the company produces, it makes sufficient quantity based on economic order quantity (EOQ) model and batch size requirements. By doing so, the company achieves stability for the large-volume products and agility for the small and volatile products.
Drive out sources of supply volatility and manage supply reliability issues: The number of rejected batches for Gx manufacturers is 1.4 percent, more than three times the rate of Rx manufacturers (0.4 percent). Supply chain plays the key role of bringing the visibility of root causes across the value chain even though it might not be the owner of the process where the root causes occur. Specifically, this means systematic tracking and investigation of nonworked time or lost shifts, overall equipment effectiveness (OEE) losses, and schedule changes. An example of effectively responding to supply volatility comes from a Gx manufacturer that was experiencing an increase in long-term stockouts and service issues for ten SKUs. The root cause of this unreliability was an API supplier’s loss of GMP status following a very poor inspection. Comparable issues were also occurring in other countries. The supply chain had managed similar challenges for the Japanese market with a separate API supplier. Learning from these experiences, the supply chain team escalated the issue, and is now partnering with global operations and quality to address such supply risks holistically by seeking alternate sources of supply and by strengthening the supplier risk assessment program. Drive out sources of demand volatility: One Gx manufacturer was experiencing excessive inventory, multiple manufacturing disruptions, rush orders, and stockouts because of persistently over-forecasting actual demand. The company took on a focused forecast accuracy improvement program to address these gaps. One of the first changes was that the commercial and operations executives created clear, companywide guidance on promotions. Another change was to use clearer product segmentation to shift focus to those SKUs that drive near-term volatility, leveraging simple models for the stable on-market SKUs. These and other changes drove an improvement in forecast accuracy of over 10 percent within three months. Use trust-based working relationships to reduce the endless e-mails and time-consuming negotiations. Lack of accurate and timely information often leads to a lack of stability—late changes and rash decisions drive instability— that in turn drives last-minute e-mails and urgent requests. Establishing routine weekly exception management processes with cross-functional decision makers is one approach that has been adopted in both consumer packaged goods (CPG) and Gx pharma environments to improve communications. One Gx company put a regional exception management process in place to align on large forecast changes, supply projection and changes, inventory situation, and other tactical issues such as artwork changes. The process is supported by a tool that brings all critical information from different systems. The impact was rapid: within six months, service levels increased by more than 6 percent, inventories decreased by 16 percent, and stockouts fell by 55 percent. Further, the relationships between site, supply chain, and commercials, as well as between executives, improved significantly. Effectively supporting the tender business model
There are two main challenges for supply chain in the tender business model. First, in order to bid on the tender, the Gx company needs to ensure that there is reliable supply if it wins the tender. Second, winning and losing the tender can significantly change the demand profile. Even so, the volume of the business from tender is increasing for many markets, and winning tenders is critical to the supply chain and the business.
To better support the tender business model, supply chain leaders must be able to do the following:
Understand the true end-to-end costs: Leaders can readily provide cost information for commercial in the bidding, and have transparency into the total cost as well as the variable cost for each product. They also are able to understand the components of cost to inform pricing choices—learning when to account for a fully loaded cost and when to price closer to variable cost. Conduct quick scenario analysis to estimate the impact to capacity and manufacturing: Leaders have a clear understanding of their capability at asset level with modeling tools that allow the supply chain organization to conduct rapid scenario analysis on the impact and risk of tenders. Based on this information, commercial, supply chain, and manufacturing can have a fact-based discussion and alignment on how to position in the tenders. Improve tender forecasting: While many uncertainties are inherent in tenders, leaders invest to improve tender-forecasting accuracy by tracking tender history, using statistical analyses, and establishing a rigorous demand-planning process. For example, one Gx company established a three-step tender-forecasting process: tender master planning, tender baseline forecasting, and tender fine-tuning. Tender master planning is a quarterly process owned by key account management. The main focuses are to collect information of upcoming tenders from health insurance and estimate the volume. Three to six months before the tender starts, the marketing and forecasting team begins the tender baseline forecasting process to generate the baseline forecast without markups or markdowns. After the tender starts, product managers and forecasting fine-tune the forecast to include markup and markdown information. The company also reviews tender-forecasting performance such as forecast accuracy and bias. It focuses on the top offenders to make the performance review tangible and actionable. Setting up the best operating model and accountability in a highly complex and fast-paced environment
Gx companies need to manage a large amount of SKUs and a complex manufacturing network. Further, they need to manage allocation among markets when there is limited manufacturing capacity.
To manage complexity, supply chain leaders must do the following:
Manage by exceptions: Set up the system and planning parameters to handle the majority of SKUs while the supply chain focuses on handling the exceptions. Industry leaders further differentiate themselves by focusing not only on addressing the exceptions but also on bringing the exceptions down through continuous improvement. Create regional supply hubs with full accountability: FMCG companies are moving toward regional hubs, in part to simplify the interactions between operating parties and to be more responsive to changes. One Gx company, for example, had a supply chain design where each market made contact with each site to manage supply chain decisions and allocation choices. This led to suboptimal outcomes: too many e-mails, unclear priorities, preferences accorded the market most local to the site, and poor performance. In response, the company established a single point of contact for the markets. It also created a commercial position to work with supply chain and manufacturing to make trade-offs when supply is limited but demanded by multiple customers and markets. The change has resulted in far easier and more streamlined decision making as well as reduced stockouts and inventory levels. Understand the upstream and downstream effects: By seeing end-toend supply chain challenges, leaders can manage the complexity of global supply chains. Many FMCG companies have long taken a brand view that extends across functions. Some leading innovative pharmacos are also transitioning to a value stream view for their hugely important brands. Leading Gx companies also are beginning to shift from a solely functional view to one that enables better end-to-end planning for therapeutic areas or product families (such as ceph/pen/penem, controlled substances, oncology). Understanding the whole picture enables faster and better decision making. Developing long-term capacity planning to support growth The generics market is continuing to grow. For example, in Germany, the Gx prescription volume doubled between 2004 and 2012. If supply chain does not correctly plan long-term capability, they will soon run into problems. Biologics production has already experienced a capacity bubble, with excess capacity across the industry as great as 40 percent. Similar risks await other segments of the Gx value chain if long-term supply chain planning is not matched to an understanding of the business.
To manage long-term planning, supply chain leaders must do the following:
Create strong linkages with product development and commercial to understand the sources of both growth and future supply: One common problem in Gx is that there are strong silos within product development, commercial, and supply chain functions on new product introduction. Gathering demand forecast for new products is often hard and manual. The demand information is shared with the supply chain only at the late stage of the new product introduction process, preventing the supply chain from effectively planning its long-term capacity. Leaders in FMCG and innovative pharma have extensive integrated launch-planning efforts and a clear process for information sharing. Use sales and operations planning (S&OP) with scenario analysis to align all stakeholders on a long-term capability plan: An additional practice that leaders have put in place is to have clear linkage between new product-planning processes and S&OP processes for all stages of new product introduction. Long-term planning of new production introduction is a key input to the strategic quarterly and long-term S&OP process. Shorter-term launch planning is integrated with the monthly mid-term S&OP process. The cross- functional team reviews, discusses, and aligns the actions to be taken in response to changes in market assumptions and supply situation for new product (for example, reduced new product launches uncertainty as launch time grows nearer), along with on-market products. As a result, all stakeholders have clear roles and responsibilities on new production planning and can effectively plan long-term capability.
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Gx supply chain leaders deserve to feel proud of their progress, particularly relative to the performance of their branded peers. That said, however, the key question for these companies is how to build on their strengths to ensure cost effectiveness through stable manufacturing, high reliability, fast reaction times, and sufficient capacity in a highly challenging environment. They must continue to leverage integration, agility, and continuous improvement not only to drive a higher performance level but also to avoid a constant state of firefighting. The task ahead is admittedly daunting, but their considerable progress thus far should give supply chain leaders the confidence to persevere.