Pricing in the Pharmaceutical CDMO environment

Outsourcing the manufacturing of a product comes at a price. Sometimes metaphorically but always literally. What is the right price to pay to outsource your product? Who decides the price? Is it the CDMO who sells or the pharma company who buys? At the end of the day which factors affect pricing in the pharmaceutical CDMO environment?First things first. Price is different than cost and although sometimes they are related, it happens very often that they are not. This article tries to explain why this may happen and give some food for thought for different parameters affecting the price that a CDMO charges (or the pharma company pays to outsource the product).There are two perspectives of this topic. First is the angle of the CDMO and then there is this of the pharma company who outsources. Let’s start with the first one. When a CDMO offers a price for a product, probably the first parameter that considers is its cost. What is the cost of materials, the direct cost, the fixed cost etc. It is not uncommon that this is the only parameter that CDMOs take into consideration and this is what I call Cost Plus pricing strategy, where a cost is calculated and then a specific margin is put on top in order to calculate what price to offer. This is the easy but at the same time more simplistic approach, which sometimes leaves some money (value) on the table or in other cases may lead to rejection of the offer due to uncompetitive price. This is because the Cost Plus pricing strategy does not take into account market related factors.

Market related factors include what competition offers for the same product but also what the customer (the pharmaceutical company which outsources) is willing to pay for the specific product. It is the combination of three elements that should, in my opinion, be considered when a CDMO offers a price. CDMO’s internal parameters, Competition and Customer’s willingness to pay.

CDMO’s internal parameters should not include only cost related factors. There is so much more than the cost that should be considered. It was some years ago when I was about to propose a price to a customer which asked for a price without API. It was a low annual volume product (couple of batches per year), difficult to produce and API would be provided by the customer free of charge. During a meeting where we would discuss what price to offer, the CCO asked the question. What is the Value of the API? Since the API price would be provided free of charge, nobody had bothered to evaluate what was its cost. But it turned out to be that this was a crucial point because the API value finally was double than the value of the remaining batch cost. What would happen if a batch failed due to CDMO’s fault? It was calculated that if the CDMO had to pay for the value of one rejected batch, this would mean that not only the profit of one year would be evaporated but also CDMO would run at a loss. It doesn’t matter what finally was decided in the specific example. It feels to me that this is a nice example explaining that cost should not be the only parameter that should be considered when a price is about to be offered to the customer.

But of course, there are more. Free available capacity, difficulty of manufacturing the product, complexity, expectations of more business from the specific customer are some of the internal parameters that should be considered. It maybe the case that the CDMO charges a premium for a product that is difficult to manufacture, especially if competitors cannot cope with it. Similarly, if free capacity is limited, maybe it makes sense to charge a premium for giving away this limited free capacity. On the contrary, if the specific project is a door opener for a new promising customer, then it might be wise to consider sacrificing part of the margin, in order to bring the customer in. This of course is related to the strategy of each CDMO. Some have a growth strategy, for some others next year’s EBITDA is more important.

It is not the scope of this article to go into details. It is to give some food for thought and therefore further elaboration of internal CDMO’s parameters will be avoided. And this gets us to Market related factors.

Since what price competition is offering for similar products is difficult to know, unless maybe you ask for external advice, lets jump to what the customer is willing to pay for the specific product. CDMOs should, in my opinion, put themselves in the shoes of their customers for a while.

Is the customer willing to pay more because the CDMO has limited free capacity? Does the customer care if the CDMO has a growth or an EBITDA related strategy? Probably not, but maybe a difficult manufacturing process plays a role in the price that pharmaceutical companies are willing to pay. Of course there are more important parameters that the latter consider when deciding on what is a fair price to pay. The most important of which is what margin this price (which is a cost for the customer) leaves them on the table. And this is where it starts to get difficult for the CDMO. Defining what is the margin of the customer, letting alone what margin is enough for their customers might be seen as a long shot. Nevertheless, there are some ways to approach it. And the closer they get, the better the chances are for defining the right price for the product.

Is it the same if a product is a commodity like generic paracetamol tablets as if the product is an innovative lyophilized vial, patent protected? Manufacturing technology, therapeutic area, competition in the market of the pharma company (how many other pharma companies market this product) and country of sale are some of the parameters that affect what is the willingness to pay.

A good approach for the CDMO to define the margin that its price will leave to its customer, is to see what is the price of the specific product in the pharmacies in different markets, remove taxes, pharmacy margins and distributor margins and get a flavor of the margin that its customer will have. Of course this is not enough. Different pharmaceutical companies have different expectations on their margins but in general there are specific patterns. For a commodity like a generic paracetamol tablet probably something around 60% is fair enough. On the other hand, for an innovative lyophilized patented vial, they would expect something around 90%. These figures exclude rebates and marketing costs that pharma companies need to pay. If the CDMO does not consider factors like this, providing a price only based on internal parameters significantly reduces the chances to provide the appropriate price. Although it is difficult for many CDMOs to run this exercise, it probably worth the time and the effort.

Yet, margin is not the only factor affecting what is the willingness of a pharma company to pay. Culture, location, quality, cooperation, responsiveness and flexibility of the CDMO also affect customers’ willingness to pay. If the pharmaceutical company is satisfied with the service level they get from a CDMO, if they feel that they are important and their supply is secured, they are probably ready to sacrifice part of their margin as opposed choosing a CDMO with a lower price but also a lower service level and higher supply risk.

And of course, the better the pharmaceutical companies outsourcing their products are informed about what is the average price in the CDMO market for the specific product, the more ready they are to answer what is the fair price to pay.

Most pharma companies know that persisting in receiving a very low price from a European CDMO only because they want to keep their margins at a certain level, will not work in the long run. If the average conversion price in the European CDMO market is 2 cents for a simple tablet, asking to receive it at 0.5 only because they want to keep their margin above 60%, is not realistic.

Even if there is a CDMO that will accept to provide such price, in the long run this cannot be viable. His costs will continue increasing year after year and one day he will ask to change the price to a level which will be closer to the market average. Or, worse, he will inform the pharma company that he cannot afford continue producing it anymore.

So, answering the question what is the right price to pay (or to charge) it needs market knowledge. Knowledge of the CDMO market but also knowledge of the pharmaceutical market. CDMOs should put themselves in their customers shoes but the opposite is also true in order to have a healthy long-standing cooperation.

Knowledge of the market is important. Get to know your market but also get to know your customer’s market. Combining both will make you better prepared to answer the question of what is the right price in the CDMO environment.

Designing a new business plan in the Pharma CDMO industry. Are you ready to wait?

There are times in the life of an organization when the reset button needs to be pressed. It might be the period following a crisis or the change of ownership, in the aftermath of an acquisition or maybe when a new operation within the organization is about to start, or just because the growth and/or profitability rate is not on the desirable level. And this is when a new business plan is usually required. The new owners, the new Members of the Board, the new investors or the new CEO want to know what to expect for the next years. And as someone I worked with in the past used to say, it is important to know Who will do What, by When.And this is where the tricky part begins. The strategy and the business plan for the next years need to be structured by people who are familiar with the business. Experience has shown that it is not wise to trust experts from another industry or consultants that are generalists, to build your future. It is easy to say that in the next three to four years figures will explode but especially in the pharmaceutical CDMO industry it is not that simple.This article attempts to explain why and manage expectations of new Investors, Members of the Board or companies willing to start a new integrated CDMO organization within an existing organization. CDMO business is for those who can wait, and the reason is simple. All the effort that a CDMO puts now, all the new proposals it offers to customers, all new business agreed now, will bear fruits gradually in the future. This is because of the long timelines required for transferring in a product to a new manufacturing site and all the uncertainties coming with it. Moreover, before even reaching the transfer in stage, it takes time to prepare a quotation and to get a positive feedback from customers.

So, next time you hear someone building an aggressive business plan in terms of timelines and growth in the pharma CDMO industry, ask for details and look for realistic explanation. Important rewards should be expected at least 5 years later. Let’s see why with an example.

First let’s set some basic assumptions. Usually periods following a crisis, change of ownership, or attempts to set an organization from scratch require a reset. This means that limited or no new business has been agreed at time zero. Therefore, all effort starts now. And effort begins by providing new quotations to customers, wait for their response, and ultimately agreeing some new business. Then, begin the technology transfer, succeed in validation batches, perform stability studies, register to health authorities the new manufacturing site, hoping that everything will go according to plan. Only then the CDMO is ready to start producing the commercial batches.

The below example uses the following basic assumptions:

Target for revenue coming from new business is set to 100. Let’s see by when this target can be reached taking the below assumptions:

  • Each year the CDMO has the resources to submit quotations of 100 worth of revenue
  • Success rate of submitted quotations to customers is set to 20%. This is the average of the CDMO business as experience has shown
  • So, according to this success rate, each year the CDMO can agree 20 worth of revenue from new business
  • Completion time of transfer: 18 months
  • Revenue of new business agreed coming from routine productions will come gradually. In an optimistic scenario: 25% on the first year, 75% on the second year and only in the third year the full agreed revenue will be materialized. This is because in the first year, some limited revenue might be expected from validation activities, in the second year routine productions will not start in the beginning of the year, or not all SKUs will be produced (for a more complex project), and on the third year, assuming that all countries have been registered to health authorities and transfer is successful, full quoted revenue can be expected.
  • For simplicity reasons, no discontinuation of existing products will occur as well as current portfolio will have no fluctuation in the foreseeable future.

The below table shows how agreed revenue from new business will be materialized through the years.

No alt text provided for this image

Due to the reasons described above, revenue will come gradually and as it shown by the table, total target of 100 cannot be expected to be achieved before year 6. Moreover, the total benefit from 5 years effort will come in year 7.

This is an optimistic scenario assuming that everything will go according to plan during the transfer process, and volumes agreed during the quotation phase (and subsequently revenue) will be unchanged. Experience has shown that many of the products that outsourced to CDMOs in the pharma industry are mature products with a tendency to lose market share as years go by. Therefore, it is not strange for CDMOs to see agreements made 5 or 6 years ago to be different than actual picture in terms of annual volumes and thus revenue. Furthermore, exactly because of the nature of the business it is also not strange for CDMOs to experience volume erosion of existing portfolio as years go by.

Nevertheless, the example used here assumes all other parameters to remain the same as in year 1.

No alt text provided for this image

Of course, someone could argue that there are ways to bring the final target closer to year 1. The main two ways to do this is to increase either the number of RFQs (by increasing your resources to prepare and submit offers and your ability to identify more opportunities) or increase the success rate of submitted quotations to customers. The first one would increase your level of submitted quotations and the second one, the level of agreed business.

The first solution requires hiring additional people both within business development dpt. and maybe also in operations. Moreover, a more efficient RFQ management for faster responses can help. It might also require changes in the way of RFQ approach and move from reactive approach to proactive approach in RFQ management. This means that instead of waiting from customers to ask you for a quotation, find ways to provoke quotations requests than waiting to be asked for.

The second solution requires better costing and pricing policies. What the product that is about to be quoted should cost and what the customer is willing to pay for the specific product. Better understanding of what the competition is offering for the specific product types can also increase the success rate. In other words, move from cost plus to market minus approach.

The above example deals with the part of the business plan related to revenue evolution of the business. It has to be translated to EBITDA evolution for the coming years by estimating the Gross Profit of the new business and include any additional expected indirect cost on top (indirect personnel, promotion, exhibition participation etc). Investments down the road need also to be defined according to the adopted Investment Policy.

Summarizing, CDMO’s Top Management needs to comprehend the time parameter of the business, manage investors expectations and rely on a challenging but realistic business plan, based on production technologies and company strategy, developed by hands-on field experts within and outside the organization.

Furthermore, in order to secure successful business plan implementation:

  • Targets have to be set and achievements, towards the targets, to be monitored on monthly basis.
  • Clear Roadmap to be developed and Key Performance Indicators to be established for progress monitoring.
  • Progress toward business plan to be reviewed constantly and adjustments/changes on needed actions to be implemented if necessary, in order to remain aligned with the business plan.

Fuliginous Management Ltd specializes in the pharmaceutical CDMO business and its consultants carry many years of experience in this field. We know what it takes to increase both the level of submitted quotations and the level of agreed business by developing tools, models and processes tailor-made for our customers’ needs. In other words, We know What to do by When in order to make a CDMO succeeding in securing profitable organic growth.

If you are ready to design your next business plan, get in contact and we will build together an ambitious, realistic and achievable business plan that will not need adjustments every year since it will be based on solid assumptions, clear steps, measurable actions and KPIs.

Defining the right Profitability Measurement in the Pharma CDMO industry. Easier said than done

Profitability is a topic which takes the lion’s share of discussions within business environments. “Profitability last year was not as expected, profitability of this new project is not high enough, that product has a negative profitability ” etc.

Every CEO, every business development vice president, every business unit head, let alone the CFOs, discuss it with their boss all the time. And even if the overall company’s profitability is the top of the iceberg and it is measured by EBITDA % over revenue, the question remains of how the profitability should be calculated for potential new projects in case they are incorporated into the company’s business i.e., how the new project will affect the company’s bottom line.

Adopting the most representative measurement in the effort to predict the profitability impact of a new project, is vital for facilitating managerial decisions that are aligned to the specific CDMO business strategy.

I’ve taken part in numerous discussions in the past with different CDMOs of the pharma industry, trying to determine which is the most realistic way to measure profitability of a new product that is about to be quoted. To answer to this question, the CDMOs need to determine what costs should be taken into consideration. And in many cases, this is much more complicated than it sounds. At one extreme there are examples of CDMOs that add to the cost all direct, fixed costs and overheads of the company (somehow allocated) and at the other extreme there are CDMOs who include only direct costs required for the production of the specific product.

No alt text provided for this image

Apart from the direct costs associated with the production of the product (direct labour and materials) should we add to the cost part of the equation, fixed costs and overheads? And if yes, which of the fixed costs and overheads? In the above, simplistic example of an imaginary product, is the profitability 50% or 0%? Or maybe 25%? Is there a golden rule of calculating profitability that fits all CDMOs? If the above figures were the figures of a new product awarded to a CDMO, would this be a profitable business or not? Would the CFO and the Commercial director be happy with this? (if ever Finance and Business Development manage to agree on something)

Instead of trying to answer to these questions, let me put some more questions on the table…

  • Does the manufacturing site of the CDMO runs at full capacity or is it more or less empty?
  • Does it already cover its existing fixed costs?
  • Does the new product require additional investments in order to be produced or is it a plug and play one?
  • Can the new product be produced with the existing indirect resources of the site?
  • Is the overall company strategy a short term one (2-3 years) or a long term one (3-7 years)?
  • Is the CDMO a listed company or a family owned business?

Some of the above questions may sound irrelevant to the initial dilemma (i.e. which is the most appropriate way to express profitability), but in reality they are not. In fact, it matters for example if the CDMO belongs to a fund whose goal is to sell the company in the next 3 years in a price that is multiple times of its EBITDA. This is different from a CDMO belonging to a family whose main goal is to increase volumes and revenue. This is because in the first case an increase of 1million in EBITDA will result in 10 million maybe, in the pocket of the fund (due to the fact that they can sell the company 10 times more than its EBITDA) while in the case of a family-owned business, an increase of 1 million in EBITDA will stay as is if there is no vision to sell the company. Therefore, if this was the only factor affecting the decision of which is the best way to measure profitability (which is not), the CFO of the first CDMO would insist that every new product entering the site, should cover all allocated overhead costs (and generate EBITDA increase with every new product), while the CFO of the second CDMO might be happy if only fixed allocated costs were covered.

But, since the structure of the CDMO is definitely not the only factor affecting the most appropriate way to express profitability, let’s see how other factors contribute to the decision.

Let’s assume that a pharma company has requested from two different CDMOs to confirm if they can produce product X at a given target price of 100.

Below there are some assumptions for each of the CDMOs. They are extreme cases, for the sake of argument.

No alt text provided for this image

In the case of CDMO 1, the new product will not add additional fixed costs, will not require additional investments and its capacity utilization is quite high, meaning that its current fixed costs are already covered. Moreover, the process for CDMO 1 will be 100% manually, meaning that no machinery will be used for the production of the product. Finally, there are small general overheads and the equipment in house is old and therefore already amortized and paid off.

For CDMO 2, everything is opposite.

If both CDMOs have the same direct material and labour cost for this product (let’s say 50), both of them will have a contribution of 50%. (Contribution = Unit Price – Direct Cost). However, CDMO 1 does not need to cover any existing fixed costs (due to the 80% capacity utilization) while CDMO 2 cannot afford to add products in the site if they do not contribute heavily to the fixed cost absorption.

Similarly, CDMO 1 does not have to worry about financing increased fixed costs as well as investments required for this product, while CDMO 2 does. Finally, the fact that the general overheads are low for the CDMO 1, probably means that the salaries of the corporate team have already been covered by the existing products. For the CDMO 2, which is much bigger with higher general overheads and recent investments into equipment made, new products entering the site(s) should not just cover their cost but also heavily contribute to the absorption of general overheads.

Considering the above, CDMO 2 in his profitability calculation should take into account the high fixed costs he has to cover. Hence, a gross profit calculation, that helps him to do so is very much needed. (Gross Profit = Unit Price – Direct Cost – Fixed Cost)

The above extreme example presents two different profitability measurements, Contribution and Gross Profit. If CDMO 1 decides to use purely the Gross Profit measurement, inevitably in his attempt to do so, will allocate part of the fixed costs to every new product that will enter into the site. If for example the CFO sets a target of 20% Gross Profit for every new product, this means that price should be 25% more than the sum of direct and fixed costs of the product. (because if direct and fixed costs equal to 80, a price of 100 would lead to 20% gross profit, but 100 is 25% higher than 80).

However, if fixed costs have already been covered or are zero for new products (in the extreme above example) this will lead to a false cost calculation and wrong profitability figure. There is no point in measuring Gross Profit in this case. Contribution is a much preferable measurement as it focusses on the direct cost and gives a profitability picture much closer to reality.

To put it in another way, if fixed costs do not really change with the addition of new products, Contribution is a more appropriate reference. If on the other hand, CDMO 2 starts measuring Contribution and forgets about fixed costs and Gross Profit, it will find himself very soon with a full manufacturing site that probably does not cover its fixed costs.

The same is true not only for new products but also for discontinuations of existing products! If a big volume product is discontinued, its negative effect on the site is much higher than its current Gross Profit, in case fixed costs do not decrease accordingly. Imagine for example that an existing product with annual Gross Profit of €20K and annual Contribution of €50K is discontinued. If fixed costs do not go down (and usually this is the case), the negative impact on profitability is not just the €20K per annum. The Contribution should be measured as a loss in this case (depending also if direct labour costs will be removed or not).

Even more attention should be given to negative Gross Profit products that are discontinued. Let’s assume that a minus €20K Gross Profit product has a positive €30K annual Contribution. If this product is discontinued, the effect that will have in the overall picture of the site (if fixed costs do not go down) will be negative at least by €30K and not positive by €20K.

Probably keeping an eye to both measurements makes sense and there is no golden rule that fits all cases. Neglecting one of them completely is also false.

So, next time that you are about to calculate the impact on profitability of a new product or a product that is about to be discontinued, be careful on what measure you will use. Similarly, when setting targets for profitability of new products, think twice which is the most appropriate measurement for your company. It might sound easier said than done, but it does worth the effort to put some thought on it.

External Manufacturing Network of Pharma companies without own-manufacturing facilities

“…do we work for our company’s benefit as well or just for the benefit of all other parts of the supply chain industry…?”

Commercial Pharma Companies

Out of a sample of 320 pharma companies operating in Europe and listed in our database, more than 120 do not have own-manufacturing activity, focusing mainly in commercializing products. The vast majority of these Commercial Pharma Companies (CPCs) market traditional technology products that face increased competition in the market.

Not having manufacturing capabilities CPCs rely exclusively on their External Manufacturing Network for having their products ready for sale.

How External Manufacturing Network looks today in CPCs?

The products that CPCs market, come from in-licensing, product acquisitions or own product development. In-licensing seems to be preferred to the other two models since it allows fast market entry, limited initial investment and manageable risk for the first years of product commercialization. On the other hand it lags behind the other two in product Gross Profit (GP) margin, flexibility in future product changes and manufacturer selection as well as in the company’s valuation for the future.

For all three models, at the time of the deal/decision the Gross Profit of the product is supporting the business case and this is usually the case for a number of years. As time passes, product commercialization cost as well as product supply cost increase (supplier price increase requests, additional requirements from authorities, …). On the contrary prices stay flat or decrease resulting, after a period of time, to product Gross Profit shrinkage well below the product category market average. This is the time when stockholders question themselves:

“…do we work for our company’s benefit as well or just for the benefit of all other parts of the supply chain industry…?”

The drop in GP, at a point in time, raises question marks if it really makes financial sense to keep commercializing the product and also creates unpleasant thoughts about the survival of the company in the future. These concerns oblige CPCs to escape forward by introducing new products with better GP (than the existing ones) in order to keep an acceptable EBITDA for the company. This is a non-ending cycle since the new products GP will again shrink after a period of time.

Unavoidably, the increase in the number of products of a CPCs leads in adding new suppliers in the list that subsequently increases complexity and administration cost. Also risk management becomes more and more an important parameter for the business going forward.

After examining a number of products (917 products for which information could be found online) of a relatively small sample of CPCs (20), the three major findings are:

Diffusing a given business to a big number of suppliers deteriorates CPC’s weight per supplier. This may lead to limited attention from supplier’s side towards the CPC.

Having a big number of suppliers for products of the same product technology could make the loss of opportunity more intensive since potential synergies are also not obtained.

Using suppliers for which contract manufacturing is not a core business may lead to limited flexibility, less competitiveness for the product and higher risk for being in a position to find a new home urgently at a point in time.

The External Manufacturing Network situation, as described above, seems to be mainly a result of the combination of three factors:

  • All attention of the company is given to increase the top line without really managing the cost
  • In-licensing model
  • No organized effort in optimizing existing suppliers network

Does this mean that CPCs should stop focusing in top line growth and in in-licensing? Definitely not! This should continue according to the company’s strategy. At the same time though network optimization should take place and an Outsourcing strategy has to be established to support a sustainable growth.

 Does External Manufacturing Network optimization worth the effort and investment?

So, if there is important value to be gained in suppliers’ network evaluation and subsequent optimization, why such a project is not one of the top priorities in the CPCs?

The main reasons are:

The potential benefit is not clear due to lack of benchmarking information. A business case cannot easily be created based on cost / benefit analysis. This creates hesitation in occupying resources and initiates a project with unknown outcome.

There are uncertainties related to potential product transfer difficulties that could not be foreseen from the beginning. This is true with old product files with vague process descriptions and for which a transfer process could trigger additional requirements by the authorities.

Fear to spoil the relationship with current suppliers is involved. Good relationship with suppliers is of high importance and there is a fear that “difficult” discussions would harm the relationship especially if some other products remain with the suppliers.

Contracts include obligations or clauses that limit CPC freedom to select supplier of choice. This is usually the case with in-licensed products.

Supply portfolio risk evaluation is not performed and thus related risk is not realized.

Suppliers’ network evaluation and optimization program, addressing the uncertainties mentioned above, could deliver a number of important benefits:

– External manufacturing annual spend reduction between, indicatively, 10% and 15%

– External manufacturing network risk management and risk mitigation

-Lower internal cost for efficiently managing suppliers

-Increase company’s weight on fewer preferred suppliers

The answer to the question in the title of the paragraph is YES if it is based on solid business cases that take into consideration real market assumptions.

 What should be done and how?

The most decisive step is the thorough evaluation of products and suppliers.

-Product Price benchmarking would define products with higher price than market average.

-Analysis of product category GP and comparison to market average would indicate areas of attention.

-Product restrictions due to contract clauses should be taken into consideration.

-Supplier evaluation based on criteria according to company’s strategy would show preferred or high risk suppliers.

Combining the outcome of the above analysis, a number of product bundles would be identified as business cases either due to high price / low GP or because of high risk suppliers.

Cost / benefit evaluation of the business cases, based on clear assumptions according to market standards, will rank them according to expected overall benefit and define the action plan and priorities going forward.

In the implementation phase, assumptions should be tested and, if necessary, modifications of the business case should be done before proceeding with the change implementation.

As companies grow it is inevitable that new products and suppliers will be added to the list. Having a clear outsourcing strategy and running a product and network review, within specified intervals, is the recipe for achieving and keeping an optimized External Manufacturing Network.

 

Master Data Management in the Pharma CDMO business. Neglected but necessary

What do you mean you don’t know how many packs of Product Family X we sold last year from our 3 manufacturing sites?” asked the supply chain director, of a midsize CDMO, her team?“Well, it is not so easy to reply to this, we will need some time. You know, every manufacturing site does not use exactly the same name for this product let alone that different markets (SKUs) have slightly different names for it. So, we will need someone who knows what products are included in this family and also some time and manual work to group them together and to gather this information”.At the same time, in another meeting room in the headquarters of the CDMO, the CFO asks his team to inform him about the revenue and profitability of the top 10 sales products and their evolution since last year. Therefore, one member of the finance team has to communicate with the 3 manufacturing sites, ask for this information, maybe clean up what he/she will receive and finally put it in the format that the CFO expects to see.

Reading the above, one can argue that there is nothing difficult with the above tasks. And in reality, indeed, there should not be. However, imagine this. One of the products in the above questions is Ibuprofen for customer X in three different manufacturing forms: Tablets, syrup and suppositories. Each of them is produced in a different manufacturing site of different countries. Experience has shown that a Spanish site can name such SKU like “Ibuprofeno”, a German Site may use the English term and call it “Ibuprofen” while a French site may spell it Ibuprofene. At the same time one SKU in 1 country may be spelled differently than in another country.

And it is not only Ibuprofen. Take its rival, Paracetamol for example. When I first heard about Acetaminophen I didn’t know that it was the same with Paracetamol. So, when I was asked to split the volumes of a specific customer in different products, I separated Paracetamol from Acetaminophen SKUs. And the same happened to me, when I was asked to look if we produce Vitamin C products in the company. I looked for Vitamin C, but I didn’t look for Ascorbic Acid. Nobody told me that they are the same.

If there is a system in place to group all Ibuprofens (including those with an “e” or an “o” at the end) together, and to tell people that Paracetamol is the same as Acetaminophen, and Vitamin C the same with Ascorbic Acid, life will be easier for those who want to look at the big picture. And it might be sound easy for those who work in the manufacturing sites and deal with them every day, but corporate people in finance or business development are not familiar with such things. So, when their boss asks them to gather together such information, they need more time than they should, to answer such simple questions.

The same problem, if not more intensive, is confronted when it comes to raw materials. How easy and accurate it is to report what our total spend on a specific material is, how many suppliers do we have and what the potential benefit would be in different scenarios evaluation?

And then it is not only the terminology. There are also human mistakes that happen every day. Someone can spell Allopurinol, Alopurinol (by missing 1 of the 2 “l”s). Or someone in one department spell instead of GSK, GlaxoSmithKline for example. Or one department spells Teva and another Teva Pharmaceuticals. Let alone that Actavis belongs to Teva now so if someone wants to find the sales towards Teva, he should probably also include Actavis SKUs in his calculations.

Here comes Master Data Management (MDM) whose definition in Wikipedia is “a technology-enabled discipline in which business and Information Technology (“IT”) work together to ensure the uniformity, accuracy, stewardship, semantic consistency and accountability of the enterprise’s official shared master data assets”.

In other words, we need Master Data Management in order to make sure that there is a common rule between all 3 different manufacturing sites that says that whatever way the Ibuprofen SKUs are spelled in the artwork of the box, in our ERP system we will have a field that it should mention that all of them belong to “Ibuprofen” family. And the same for Paracetamol and Acetaminophen. When someone from the top management asks what is the total revenue, profitability or volume in bulk units of Paracetamol, the system should gather together this information with 1 click. And then with MDM nobody will be allowed to spell GSK, GlaxoSmithKline in our ERP system anymore. There will be a drop down menu somewhere which will only give you the option to select GSK.

I know that most of the above examples do not apply to small companies with 1 manufacturing site and 10 or 15 products, but for pharma companies with a bit more of complexity it definitely worth the time and the effort to try MDM. Even if it does not seem necessary now, if there is a vision to grow the company, MDM will become a necessity very soon. So, it is better for people in the mid sized companies to be familiarized with this.

Especially family-owned businesses that want to grow and maybe acquired by a private equity in the future, this is something that will definitely be required. People in private equities are usually not familiarized with the specific business and that is why they ask a lot of questions. And the more questions are raised, the more important Master Data Management gets.

It is not the simplest task in the world and definitely people inside the manufacturing sites who only look the picture of their site will not agree that this is necessary, because everyone knows the Ibuprofen SKUs and everyone knows that Acetaminophen is Paracetamol. So, they don’t need a system to tell them how to group the products. And it takes time to classify SKUs and to fill so many fields in the ERP system. So, why to do it?

And here lies the problem. Those who need Master Data Management are different people than those who need to feed the system in order for MDM to work. If the person who creates the SKU into the ERP does not fill at the time of the creation all the necessary fields, the corporate person who needs to answer to the questions of the CEO or the CFO, will never be able to see the advantages of MDM and he will be forced to group things manually and make assumptions where he is not sure.

I still remember, many years ago, the saying of our IT Director: “garbage in – garbage out”. He meant that the quality of information that you will retrieve from your ERP system will be the same with the quality of information you input to the system.

Important managerial decisions but also strategic decisions are most of the times based on trends and historical data and this kind of information needs to come fast and to be accurate.

This is why a corporate policy needs to be defined, where a RACI table will clearly mention who is responsible for what and ERP systems should have rules to secure that an SKU will not be created if certain fields are not filled. But something like this needs to come from the top. Directors of different departments (IT, Supply Chain, Operations, finance, business development, purchasing etc.) should agree that this is an important task and collaborate in order to establish a Master Data Policy. It will never look like a priority because everyone has its own everyday fires to put out, but if this works, the amount of time and mistakes that will be saved will be enormous.

The long transition from Family to Private Equity owned pharma business. Get ready for “some” changes

You see, there is no better or worse option when it comes to the question which is better, a Family-owned business or a Private Equity owned one? They are simply different. There are examples of successful businesses of both types. The biggest share of Roche belongs to Hoffmann Family, Boehringer Ingelheim and Fareva are Family owned and all of them are undoubtedly successful. On the other hand, Stada is owned by a Private Equity firm and the same goes for Ethypharm which are also highly successful”. These were some of the first words that people working for a pharma Family-owned business that was about to change its ownership status to Private Equity, listened from the new management.And indeed, this is the truth. You can find successful examples in both banks of the river. However, they are indeed also very different. And there is a reason that they are different. There is a reason why expectations and targets are usually different and there is a reason why the transition is full of changes on the way of working.

The reason is that while the owners of a Family business think that they and their heirs will rule the company forever, a Private Equity wants to sell the business in the next 5 years or so. And the way to sell a business is by using the EBITDA Multiple, which may mean nothing if you don’t intend to sell the company but it is everything if selling the company is the intention. EBITDA multiple in simple words is how many times its EBITDA value can a company be sold in the specific industry. Let’s assume, that the average EBITDA multiple in the pharma business is 10. This means that if the annual EBITDA of a company is 10 million euros, it can be sold for around 100 million euros (of course other parameters like debt, pipeline, IPs etc. also affect the selling price).

This alone, is enough to change everything in the priorities as well as in the way of working. While annual volumes in packs and annual revenue (and cash in pocket) is important for a Family business, it does not mean much for private equities. EBITDA is the king and this is because at the end of the day the company will be valued and sold based on its profitability and not on its annual revenue or on how many packs it produced last year.

So, few months after the first words, mentioned in the beginning, some other words kept coming…

“What is the value of our pipeline for the next 5 years? What part of the repricing that we made to our customers last year, was covering material cost increase, labour cost increase and profitability increase? Can you calculate for me the impact on EBITDA (not just gross profit) of this new project? And if we decide to discontinue that unprofitable product, what will be the impact on EBITDA? Our CFO asked to know what will be the benefit on profitability if we finally decide to acquire this new ERP system that we asked for. Can you make a cost-benefit analysis and give me the ROI on this ERP system?

“And we need to stop measuring the size of the RFQs we receive in terms of annual volume in packs and start talking about revenue and even better profitability.

“Our new owners are not so much familiar with the pharma business, so 5 million packs do not mean much too them, 5 million euros revenue does mean a bit more and 5 million EBITDA is their mother language.”

All of them are valid questions, the problem is that if there are no tools, systems and procedures to answer those questions, people working in the company, need to set them up. New tracking tools should be prepared, new reporting tools should be formed, new procedures should be in place. And of course, someone has to support the people during this transition and explain to them why all of these questions are asked and why all this new information is important for the company. Someone needs to explain that although it was not important so far to know the pipeline for the next five years now it is very important. Even if it was not necessary up until now to show every month how we perform vs the 5 years business plan, now it is important because our investors need to be assured that we know what we do and we have the situation under control. It is particularly important to know Who will do What by When because in this way we show to our investors that we have a plan that will allows us to meet the 5-year target and finally the company could be sold at a desirable price at the end of the period.

But in order to know Who will do What by When, a tracking tool is not enough. Even if the tool is there, people have to learn what to feed it with. They need to change their mentality and shift from “securing a new business is great” to “securing a new business is great, but it’s not enough. You need also to report it”, otherwise top management will not know about it and investors will not be confident that everything goes according to plan. While in a Family business (especially the small ones), the owner might take part even in the negotiations of this new business and he will probably know even the tiniest of details such as what is the output of the IMA packaging line, things are different under Private Equity. The administrators will not care about the details, they have other worries. And definitely they do not know what a good output for an IMA packaging line is.

Apart from reporting what you should do and by when in order to meet the target, the other impact of such transition may be on the focus on customer satisfaction. Usually, Family business puts much emphasis in the long-lasting relationship with customers and this is because of the nature of the business. It is supposed to be a long term one. Since this is not the case with Private Equity and the horizon is much shorter, it should not come by surprise if this customer focus is lost. This is a big change for people in the company dealing with customers and it might mean that instead of training only the employees of the company in transition, maybe its customers should also be trained…

There are other changes that affect people’s everyday lives. For example, it is easier for a Private Equity owned firm to invest in a new packaging line if this makes sense (if this will increase its value). Access to capital is usually easier compared to Family business. And this changes the negotiation power of people in business development for example. However, for such an investment to be approved, a business case should be drafted in a way that the top management will understand before it can approve it. Therefore, people need to learn to draft business cases and be in a position to support/present them in front of the top management.

Delays in decision making is another change that probably should be expected. In a Family-owned business, the manufacturing site head or the Business Development director will have easier access to the CEO or even the owners. This means that decisions can be taken faster. In Private Equity owned companies, things are usually different, more formal. More approval levels and alignment are required before the business case reaches the CEO and he can take a decision. I remember for example that we had to set up an RFQ steering committee that would discuss ongoing RFQs every two weeks. Even when it was made clear that this was not enough and we started discussing every week, this was the only opportunity to talk to everyone that was required for a decision to be taken regarding RFQs. And without this weekly call, no decision could be taken.

Summarizing, although one can find successful examples of companies under both types of capital structure, one thing is certain; the transition for the employees will not be a walk in the park. It will take effort and time to adjust and change in the way of working is inevitable. The best thing to do is to see this as an opportunity to learn and make the most out of this experience. Because at the end of the day, getting out of your comfort zone makes you stronger.

Contract Manufacturing Organization within a pharmaceutical company. Let the little brother grow!

It is not uncommon in families with two children that all attention goes to the big brother. The little one is not necessarily neglected, but parents do not teach the same things all over again, so he does things the way his older sibling was taught to do them. A certain modus operandi is carried on from the parents to the older brother and then to the little one. But in case the little one has different needs and is not ready to follow the steps of the rest of the family, the parents need to do something different when it comes to the raise of their second child. Otherwise, the oldest brother will be the successful one and the little brother will live in his shadow.

Something similar may happen in case a pharmaceutical company decides on top of its usual business to offer CDMO services to third parties. If this happens without a proper planning, without knowing exactly what to expect from the CDMO activities, this might lead to results that are far below expectations.

Today, based on the Pharma Companies database including more than 320 companies with operations in Europe, at least 100 of them, offer contract manufacturing services on top of their pharma business.

No alt text provided for this image

We, in Fuliginous Management, have taken part in several discussions during the last year, with pharmaceutical companies that also offer CDMO services. The main targets for doing that is to:

  • increase their top line
  • fill their free capacity
  • benefit from economies of scale in manufacturing that comes from higher capacity utilization of their site(s)

The truth is that this is a particularly good approach only if:

  • the organization comprehends that Pharma commercial business and CDMO business are two different business models and require different mindsets
  • it is followed by a vision, the appropriate strategy targets and specific action plan
No alt text provided for this image

Statements like “We will continue what we are doing so far, but instead of producing only our own products, we will produce for others as well”, make sense only for unique technologies with no free capacity in the market. In this case customers will come to you and would be probably ready to accept your way of working.

In the vast majority of the cases though, reality is less favorable. Pharmaceutical companies that consider entering the CDMO business need to understand that the success of this activity is about meeting customers’ expectations.

If you ask pharmaceutical companies cooperating with CDMOs to put down a list with what they expect from the cooperation with CDMOs, almost all of them will mention the same things. Trust, quality, delivery performance, price and communication. But they will also mention something else. They want to feel that they are on top of the priority list of the CDMO and not at the bottom.

And this is another key question for CDMOs integrated within a larger pharmaceutical company. When the critical time comes, will you prioritize the supply of your own products vs those of your customers?

Although it is clear what the answer to this question should be, lets see what it takes to make sure that customers of an integrated CDMO do not feel neglected and at the same time the CDMO is successful.

1.      Disconnect CDMO organization from the rest of the company

For a CDMO to work as efficient as possible, it should have an autonomous management and budget. It is obvious that a conflict could arise from time to time between the CDMO department and the rest of the organization, but this happens in every company, where different departments have different targets. It is like the CFO disagreeing with the Commercial Director in a big company. It happens all the time but at the end of the day when an alignment is found, the company goes forward. And alignment can take place when there is a clear strategy within the organization, which takes us to the next point.

2.      Set clear targets for the CDMO organization

In order to avoid conflict of interest within the overall organization, clear targets and strategy should be set from the beginning. A separate business plan for the CDMO part of the company should be built, which will be aligned with the overall business plan of the company. For example, future new business coming from the CDMO department, should not “eat” the free capacity reserved for the own production of the company. The business plan should be structured in such a way that it will be clear from the beginning that for example free capacity allocated to customers outside the organization is x % and the remaining y % will be allocated to own production.

This will not only avoid conflicts of interest between different departments, but it will also make clear what should be expected by the CDMO part. The business plan should be structured in a way that is realistic but challenging.

3.      Give time, do not expect results to come overnight

As explained in our article “Designing a new business plan in the Pharma CDMO industry. Are you ready to wait?” all the effort that a CDMO puts now, all the new proposals it offers to customers, all new business agreed now, will bear fruits gradually in the future. This is because of the long timelines required for transferring in a product to a new manufacturing site and all the uncertainties coming with it. Moreover, before even reaching the transfer in stage, it takes time to prepare a quotation and to get a positive feedback from the customer.

This means that you need to give time to the little brother to grow, don’t come one year later and ask for results. Be prepared to wait.

4.      Build customer focus mentality

Operating as CDMO requires customer focus. In order to trust you, a customer needs to feel prioritized as was mentioned in the beginning. When the customer faces a problem, someone from the organization should be there to make sure that the problem will be solved as soon as possible. It is acceptable that problems will occur. Every company running manufacturing operations faces problems. The key is to make customer’s problem yours and act as a partner.

And this is not easy to do if you don’t have a dedicated department for the CDMO business with customer focus mentality. If the customer calls the supply chain manager of the company asking why the track is not on his door, the latter may do not give the necessary attention if he faces similar delay issues with the own company products. On the contrary, if there is a dedicated Business Development Manager with customer focus mentality, he or she will make sure that someone within the organization will take a look at the customer’s problem. It will not be easy and will trigger conflict within the organization but this will be the first step towards finding a solution.

Usually, companies that manufacture both their own products and products for third parties do not have as priority the customer and this should change if you want the little brother to grow.

5.      Build tools and processes appropriate for the CDMO industry

Processes that are not required in a pharmaceutical company are essential for the smooth operation of a CDMO. One of the most important ones is the RFQ policy/process. It will not be acceptable from the customer to get a reply for their request for quotation after 40 days. But if there is no process in place that requires an answer to be given within 20 days for example, it might easily be the case that indeed a reply will be given to the customer after 40 days. If you don’t explain to your people what is expected from a CDMO customer, they will not know. So, a process like this helps them understand.

Another process is pricing policy that defines how price is decided and a re-pricing policy that will make sure that material increases will be passed to the customer if a clause like this is mentioned in the contract.

A quotation form template or an immediate quotation tool will definitely be useful for the CDMO and are tools that do not exist within a pharmaceutical company which does not offer services to third parties. But all those tools and processes will be essential to the little brother growth.

6.      Take advantage of the economies of scale and synergies resulting from the integrated nature of the CDMO

Disconnecting from the rest of the organization does not mean lose all the contact with the family. On the contrary, there are significant benefit an integrated CDMO can gain. For example, being experienced on the manufacturing of a specific API or a product developed by the company for example will give a benefit to the CDMO vs the competition. This type of products should be the focus of the CDMO when it comes to find new customers.

Gains can also be expected with investments made by the company in a manufacturing vessel or a packaging line for their own products. The high returns of the operations coming from the rest of the organization will help the little brother grow.

 

Some of these steps should be obvious, but unfortunately experience has shown that are not. And if you are looking for the appropriate CDMO partner try to find out which of the above are applicable. Definitely there are pros with cooperating with an integrated CDMO but also mind for the cons. Ask the CDMO that you are about to cooperate with if they follow any of these steps and then take an informed decision regarding potential cooperation.

If you are a pharmaceutical company thinking about performing CDMO activities, take a look at this list which hopefully will give you some food for thought. And if you need support, get in contact with us and we will help your little brother together!

Fuliginous Management Ltd offers services to CDMOs and to Pharmaceutical companies cooperating with CDMOs.

Scroll To Top