SCM: Pharma's First Aid Kit

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Pain points plague the pharmaceutical industry—skyrocketing expenses, stringent regulations, costly product development. Is supply chain management the cure?

On Feb. 7, 2005, Florida Attorney General Charlie Crist announced the arrests of two men and charges against a third for their alleged involvement in an interstate prescription drug operation with purchases totaling more than $1.2 million.

The three men—Joseph Gonzalez, John Cobey, and Jose L. Benitez—are accused of facilitating the sale of prescription drugs, including medication intended for cancer patients, with fake pedigrees. Under a recently instituted state law, a drug cannot be legally sold in Florida without a valid pedigree guaranteeing it is authentic and has been properly stored.

Gonzalez allegedly facilitated transactions between Benitez, who operated an unlicensed Miami drug wholesaling operation, and Cobey, owner of Atlantic Diabetic Supply, a now-defunct drug wholesaler. The drugs, which authorities believe were diverted from Medicaid between November 2001 and April 2002, were eventually sold to other wholesalers with forged pedigree papers.

"Putting profit over the health and safety of cancer patients is as low as it gets," said Crist, announcing the arrests.

The Florida incident is only one example of the pressures and challenges facing the pharmaceutical industry today. The sector is struggling mightily to respond to these issues, and leading companies are looking to the supply chain for solutions.

"This is a crazy time to be a pharmaceutical manufacturer or distributor," says Chris Holt, vice president, UPS Supply Chain Solutions Consulting Services. "They have so many new regulations to comply with. At the same time, huge liability exposure exists if their products are moving through an unsecured supply chain."

In addition, the pharmaceutical industry must contend with an increasingly difficult economic climate. Despite huge sales volume increases—the American pharmaceutical market doubled in the last five years to $200 billion in sales—profits are suffering.

In fact, profit warnings have become an industry standard. "Since June 2004, the sector has been 11 percent lower than the S&P 500," reports IBM Business Consulting.

That figure is not surprising given the following facts:

  • Fifty-six products were lost in phase three of development during the last three years, with an estimated potential sales value of more than $20 billion.
  • Between 1997 and 2004, safety-based drug withdrawals eliminated peak sales potential of more than $13.5 billion.
  • By 2008, $35.5-billion worth of products will lose blockbuster status.

"The pharmaceutical industry lags behind other sectors in basic manufacturing and supply chain performance," Holt contends.

"Managing inventory levels has never been a major concern for pharmaceutical companies in part because margins historically were so high. No one ever wanted to run out of stock, so manufacturers loaded up on more raw materials than they needed, and their suppliers did the same.

"Downstream, pharmaceutical wholesalers held as much inventory as they could—typically four to six months of any drug—to capitalize on forward buys and price increase differentials."

Pharma's Pain Points

Pharmaceutical manufacturers face additional challenges, say Roddy Martin, Eric Newmark, and Fenella Scott of Boston-based AMR Research. These include:

Sustaining growth and margins. Severe pressure to reduce health-care costs combined with high inventory levels, compliance-related processes that eat up 25 percent of revenue, and expiring product patents, result in billions of dollars in lost revenue. For generic manufacturers, low margins and limited exclusivity exacerbate the critical need to focus on cost control, speed to market, and product supply volume.

Slow and costly product development. Pharmaceutical products' complexity, plus testing and regulatory demands, result in an extended and expensive product development cycle. A typical new product costs more than $1 billion and takes seven to 10 years to develop and launch.

Regulatory compliance. The Food and Drug Administration (FDA), U.S. Securities and Exchange Commission (SEC), Environmental Protection Agency, and state governments have imposed rules and regulations on the way manufacturers operate.

To compound these regulatory demands, most pharmaceutical manufacturers spread regulatory compliance responsibilities across multiple departments, resulting in a disjointed and duplicative compliance response.

Poor operations performance. Variability in manufacturing operations leads to high cost of goods sold, inventory levels, and compliance risks. Manufacturers report massive inefficiencies, such as utilizing only 40 percent to 50 percent of capacity, reworking 50 percent of output, and losing 40 to 60 days resolving non-conformance investigations. A single scrapped product batch represents between $3 million and $4 million to the enterprise.

Unfinished business integration. Most large pharmaceutical organizations are the result of mergers and acquisitions that have taken place over the last 10 years. Manufacturers are still in the process of consolidating the new organization, rationalizing product and IT portfolios, and integrating applications to reduce costs and remove complexity from product supply networks and IT operations.

Overall, "the industry must remove hundreds of millions of dollars of waste from its global supply chains," say Martin, Newmark, and Scott.

The Wholesaler Connection

Pharmaceutical manufacturers have historically relied on wholesalers to distribute their products, eschewing direct contact with customers. Unlike in other industries, however, the drug wholesalers derived most of their profits from manufacturers.

Specifically, the wholesaler business model was to buy product as an investment, hold it until the price increased, then sell it at the higher price.

"This process represented 60 percent to 80 percent of gross margin contribution for these wholesalers," says Jamie Hintlian, a partner in Accenture's Health & Life Sciences practice. Unfortunately, this practice artificially boosted demand, caused sales volume spikes, and resulted in huge inventories sitting idle throughout the pharmaceutical supply chain.

"Over the past year, pharmaceutical manufacturers have sought to reduce excess inventory in the supply chain for two reasons: to secure the pharmaceutical supply chain against counterfeit products, and to establish inventory levels that more accurately reflect product demand," notes R. David Yost, CEO of AmerisourceBergen, one of the "big three" drug wholesalers.

"Manufacturers recognized that having more predictable demand patterns where they weren't caught off guard by speculation buying was better for the chain," Hintlian notes.

As a result, manufacturers began instituting inventory management agreements (IMAs) with their wholesalers. IMAs let manufacturers reward their trading partners for adhering to more predictable forecast and buying patterns.

"In this way, manufacturers can plan more effectively," says Hintlian, "and wholesalers are rewarded for operating in a more predictable manner."

About two thirds of Amerisource-Bergen's distribution business is now conducted under IMAs, Yost says.

IMAs require manufacturers to monitor their order volumes closely to track wholesaler compliance.

"Manufacturers need real-time visibility and control of their order streams more than ever," says John McGrory, president and CEO of software firm Edge Dynamics, Redwood City, Calif. His company's "commerce optimization" software optimizes manufacturers' incoming order streams to maximize financial performance and enforce operations compliance.

"The software sits on the edge of the manufacturer's enterprise network, 'intercepts' orders, then analyzes them in real time, taking into account contextual data points such as current channel inventory, past sales history for that particular product, and forecasted demand," McGrory explains.

"The solution then makes an intelligent decision to either accept the order, modify it, or reject it because it did not comply with business policies, terms, and conditions. At the same time, if an exception occurs, the software alerts all appropriate parties.

Eliminating Costly Headaches

"By delivering real-time visibility and control to the order stream," McGrory says, "the software enables manufacturers to eliminate costly channel problems such as speculative buying, counterfeit and unsafe products, wholesale and retail stockouts, and unauthorized chargebacks and deductions."

The software also monitors and enforces trade agreements such as emerging fee-for-service contracts, and supports regulatory requirements such as Sarbanes-Oxley and others.

While IMAs may help pharmaceutical manufacturers streamline their inventories, they've had a significant negative effect on wholesalers' business.

"Compensation available under IMAs does not equate to the profits under the previous business model," Yost writes in The American Journal of Health System Pharmacy.

"With their old profit engine eliminated, pharmaceutical wholesalers migrated to a fee-for-service business model," Hintlian explains. "The emphasis is not on investment buying, but rather on providing a menu of services for which manufacturers pay either in a bundle or a la carte."

These services include distributing product, managing inventory and service, handling product returns, administering contracts, managing accounts receivable, and providing product demand data.

"A fee-for-service model allows distributors to better differentiate themselves, to be rewarded for the services provided, to address products requiring special handling, and to increase the quality and efficiency of value-added services rendered," Yost says.

Perhaps more importantly, fee-for-service agreements properly align manufacturer and distributor incentives, which will ultimately lead to a more efficient and secure supply chain, he says.

A Crime Wave

While competition and the need to reduce costs and streamline inventories puts tremendous pressure on pharmaceutical supply chains, another force is at work shaping their structure: regulatory compliance.

"Pharmaceuticals are high-value items, and they get touched 15 to 20 times from the moment they are made until they are consumed," says Holt of UPS. "It is hard to have true visibility throughout all this movement. That creates a lot of opportunity for tampering."

Criminals know this. The pharmaceutical sector is experiencing a counterfeiting and diversion crime wave that is putting patients' lives at risk. One counterfeiting organization gained $1 million in just one week, according to SupplyScape Corp., a pharmaceutical supply chain technology provider.

More than 600,000 Americans may have received a 30-day supply of counterfeit cholesterol drug Lipitor in 2003 before the manufacturer issued a $55- million recall. Criminals pocketed $28 million in a single transaction for diluted Epogen, which kidney dialysis patients use to treat anemia.

And as many as 25,000 cancer patients may have received sub-potent medicine that was one-twentieth the strength prescribed by their physicians when Procrit was relabeled by U.S. counterfeiters. Only 8,000 of 110,000 vials were recovered; the counterfeiters gained approximately $46 million.

These drugs and others are now listed on the National Specified List of Susceptible Products identified by the National Association of Boards of Pharmacy. Counterfeiters aren't deterred, however. They simply move on to other products.

To combat tampering, counterfeiting, and diversion, state and federal officials are turning to pedigree regulations to control the pharmaceutical supply chain more closely. A pedigree is a certified chain of custody detailing each distribution of a drug, from the manufacturer, through acquisition and sale by any wholesaler or re-packager, until final sale to a pharmacy or other person administering or dispensing the drug.

Pharmaceutical pedigree legislation is pending in 26 states at the moment. "These laws say that if you sell a drug in the state, you have to show its pedigree, from the time it first appeared at the wholesaler," Hintlian explains. "Pedigree information will follow the product throughout its supply chain."

In Florida and Indiana, laws requiring electronic drug pedigrees take effect July 2006, while a California law is next in January 2007. In May, the FDA issued a statement saying it advocates adopting industry-wide electronic solutions to secure drug products.

"Neither the states nor the FDA mandate a specific technology, but Electronic Product Code (EPC) and RFID are all but required to handle the mass serialization and considerable amount of resulting transaction data to achieve automation," note Marc Meunier and Lance Travis of AMR Research.

EPC tags enable automatic, non-line-of-sight identification. With RFID, this process would occur as the cases, not the individual items, are moved past the reader.

"EPC/RFID, for example, will enable manufacturers to serialize drug products at the item level, permitting the entire supply chain to track product movement electronically, making it easier to spot and quarantine suspicious products in the prescription drug supply before they reach consumers," says John Gray, president and CEO of the Healthcare Distribution Management Association (HDMA).

"Manufacturers, logistics firms, wholesalers, and retailers have different requirements and interests, yet they will need to work together to develop standards," Meunier and Travis explain.

The HDMA, which represents more than 90 percent of the drug distribution system, supports a uniform electronic tracking system. It will take at least five years, however, for all companies to adopt the technology necessary for tracking drugs—and not all are willing to share confidential business information.

"Unless the pharmaceutical supply chain takes control of the decision-making on electronic tracking, outside forces will dictate what happens," warns Gray.

Promising Pilots

Recognizing the need for a solution to proliferating drug-tracking laws, a number of groups are currently working on electronic pedigree pilot programs.

To date, the largest of these pilot tests, referred to as the Jumpstart RFID/EPC initiative, used EPC and RFID technology and systems to ship, track, and trace nearly 13,500 pharmaceutical packages over eight weeks in 2004. The purpose was to mitigate the risk of counterfeit drugs making it to market.

The test was conducted by a group of pharmaceutical manufacturers, distributors, and retailers including Abbott Laboratories, Barr Pharmaceuticals, Cardinal Health, CVS Pharmacy, Johnson & Johnson, McKesson, Pfizer, Procter & Gamble, and Rite Aid. Accenture served as program manager, while Manhattan Associates provided RFID and warehouse management software support. HDMA and the National Association of Chain Drug Stores also participated.

The findings show that EPC/RFID can help satisfy regulatory and retailer requirements, increase product security and consumer safety, enhance order accuracy and labor productivity, and increase the efficiency and speed of recalls and returns. The group worked with the FDA's Anti-Counterfeiting Task Force on the project.

Elsewhere, consulting firm Capgemini and electronic pedigree software vendor SupplyScape recently launched the Drug Security Network initiative. Working with two pharmaceutical manufacturers and one distributor, the team mapped the necessary business processes that trace drugs from manufacturers, through the distribution system, to pharmacists.

The resulting secure supply chain was then implemented in a service-based architecture within the Capgemini lab. Each trading partner transmits and receives electronic pedigrees securely over the Internet.

Purdue Pharmaceuticals and wholesaler H.D. Smith are implementing an electronic pedigree system that will track the distribution of a Purdue analgesic product from the manufacturing facility to H.D. Smith's distribution center in accordance with Florida, California, and other state pedigree laws.

Day of Reckoning

The pharmaceutical industry is in the throes of a massive sea change to become safer, more efficient, and more profitable. And the supply chain sits squarely in the center of this maelstrom.

"All these pressures will force a day of reckoning in the pharmaceutical industry," Holt predicts. "The time is coming soon, and industry leaders know this. They're trying to balance the need for regulatory compliance and visibility with traditional supply chain best practices such as keeping inventory moving quickly, maintaining service quality, reducing costs, understanding end customer demand.

"They also need to make sure they have a plan in place to continually improve their supply chain and drive out costs," he says.

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