cost containment

Counting the cost ofpurchasing

Jean-Michel Peny and Michel Jacob examine the potential for making savings in

purchasing costs and describe how one pharmaceutical company succeeded in

reducing its external expenditure by 10%.

Figure 1: One 'l'a)' of making savings in purchasing costs involves the division of total company expenditurc into

sourcing waves, from which point purchasing costs arc the" systcmatically rcnegotiated. Source: AT Kcarncy.

Build nnd slIstllin the purchasing bcst pracricc!<.

Rl.:-t;ngincer pun.:hasing process lhruugh:

• Institutionnlising proCurCI1lCJlI best pracllccs

• RccnlÎting and lIailling (huycrs and users)

• FQOll(1hsing lools and IcchlllqllCS

\Va\'c 1

Phase nDeployment (4-5 months cach)

Anal~'st· usage ami pricing

Bl~nc.;hJ11ark/asscss supply base

Determine approaches lU hé applied

Implement and tëülise hëncfits

i\'lt:asllrc and tJ'aek J'csults

Typicall)' 6-8 soureing categoriesperwave

tic period, the total savings target isassessed and sOllrcing categories aregrouped into manageable 'waves' of imple­mentation. The waves coyer typically six toeighl categories at the same time and lastfour to five months, depending on size andcomplexity. ln this way, total companyexpenditure is divided into sourcing waves,from which point purchasing costs are thensystematically renegotiated.

Pilot studies are carried out in parai lei tothe diagnostic period in two or three repre­scntative sourcing categories. These pilotsare used to demonstrate the fcasibility ofboth the cost improvement opportunities andthe approach, and to mobilise the organisa­

tion around the project. Pilot selection is eriti­cal, since the categories to be addressed althis stage should present an opportunity forlarge savings, a contJ'act whieh ean be easily

renegotiated in a sh0I1 period of time, and

Phase 1Launching (2-4 months)

Dclin'r' rl'sults

• LOlUl1ch pilot sOllrcing categories

Concluet diagnostic

• Profilc purchases anù suppliers

• QlIalHit~' and llt'iol'iHsc opportunitit·,

• Undcrsbnd pun.'hasing prarticcs

One approach designed to generate andsustain maximum savings, with limited dis­ruption to internai resources, is illuslratedin Figure 1.

The approaeh starts with a diagnosticperiod lasting typically one to two monthsduring which purchasing eosts are assessed,

these costs are segmented into homoge­neous sourcing categories (for example,travel expenses, packaging costs) and pro­files are drawn up on cOlTesponding suppli­ers and purchasing practices. Cost savingsopportunities are quantified by performinga gap analysis between CUITent companyperfOl1l1anCe and benchmark perfolTI1ance

in two areas, purchasing praetices andpriees. The sourcing categories are then pri­

oritised according to the level of expectedsavings, the ease of renegotiating with sup­pliers and the extent of intemaJ resoureesrequired. ln the final stages of the diagnos-

How can pharmaceutical com­

pany profit margins be opti­mised? ln today's difficult

environment, increasing pres­sure on healthcare expendi­

ture from payers, falling R&D productivity,and more intense competition all combineto erode pharmaceutical company profits.To maintain their margins or at least post­pone any deterioration, phannaceuticalcompanies can pursue two lines of action ­they can strengthen their sales or reducetheir operating costs.

Multiple cost-containment measuresintroduced by governments in all major

countries, such as reference pricing, incen­tives to market generics, price cutting andgrowth ceilings, mean that opportunities tospeed up revenue increase are very limited.At the same time, programmes to reduceoperating costs have generally been syn­onymous with large-scale lay-offs.

Making savings in the area of purchas­

ing costs is an attractive and relativelypainless alternative. Such costs account onaverage for 50% of a pharmaceutical com­pany's total sales. A target improvement of10% in purehasing costs would direetlyimprove the average phannaceutical com­pany's operating margin by 20%.

The enormous potential for making sav­ings in pllrchasing costs in the pham1acell­tica! sector is due partly to the decentralisa­tion of many businesses and thefragmentecl nature of expenditure in man yuf lhese companies. ln addition, purchas­ing, until now, has not been a priority areafor reducing costs.

Recently, however, several leading

international pharmaceutical companieshave woken up to the possible cost savings

and have launched global purchasing pro­jects throughoul their organisations.

24 Scrip Magazine April 1997

cost containment

Ruy characterisation of sourcing categoriesIdentiticationand segmentation

of total buy

Vendor selection

• ivfull'iple neg(ltiations

• Agreement and comracting

• Ri:qllesl for proposai

Selection of sourcing strategies

ÙRigh

~'trllregic~1

(eg, rawmatcrjals,

advertising,eRO)

-Botfleneek ]

~ègotÎnling po \'t'cr

4elLCr-3g~

(eg, packaging,promolionaJ

male rial)

Lüw

Ù:·'"

";:;;

:il

SOllfcingcalcgory

Aildeltvalue

EXiemalpurchases

Figure 2: Both pilot studics and wavcs arc implernented in a typical four-stcp sourcing process, Source: AT Kearney.

should be representative of the company'sbusiness. Typical candidates for the pharma­ceutical sectors are packaging, printed pro­motional material and transportation.

The implementation of both pilots andwaves is a typical four-step sourcing process(see Figure 2). This encompasses the identi­fication and segmentation of the total buy,the characterisation of the buy, the selectionof sourcing strategies, and the selection ofvendors. The process should be imple­mented by cross-functional teams to ensurethat users' needs as weil as costs are consid­ered. It should also be cross-divisional and

global to take into account the total pUl'chas­ing power of the company and so delive thegreatest benefit from the exercise.

The most critical step is the selectionand development of the best sourcing strat­egy from the six potential strategies (rang­ing from volume concentration to relation­ship restructuring) and the elaboration ofthe request for proposai, negutiations andthe final selection of preferred providers.

ial, for example, average savings of morethan 17% were achieved by cutting downthe supplier base, negotiating mid-term con­tracts and removing pre-press services fromthe creative agencies. Further significantsavings were identified through standardis­ing specifications and developing demandmanagement with the prefeITedsuppliers.

ln conn'act research and clinical trials,savings in the range of 15% were generatedby negotiating selvice unit prices. FurtheroppOltunities in the field of joint processimprovement were identified, which shouldallow drug testing cycles to be shortenedand hence the time-to-market. Make-versus­

buy issues were highlighted as further areasfor study, once contractors' costs have beenoptimised through the sourcing exercise.

Overall, the number of suppliers wasdivided by a factor of between three and20, depending on the sourcing categoriesaddressed, making these areas easier tomanage and enabling putential partnershipsto be formed between the company and

selected suppliers. An additional advantageof this exercise is improved setvice fromthe supplier, who is encouraged to beproactive in offering the latest products andservices, and is more willing to participatein their joint development. This is alreadythe case in those industries with moreadvanced purchasing programmes, such asthe automobile indusny.

A result of the organisational re~engi­neering in the company was that a new pur­chasing procedure was put in place to sup­port the t'ive key operational elements ofstrategic procurement - strategie sourcing,supplier management, transaction execu­tion, measurement and tracking, and con­tinuous improvement.

The aim was to derive the greatest benefitfrom the purchasing operation by using thecompany's negotiating power to the fullwhile ensuring maximum local user satisfac­tion. Given the company's decenn"alisedstlUcture and the fragmented nature of itsexpenditure, this could only be achieved

Figure 3: One leading pharmaceutical company reassessed ail its individu al areas of e'penditure and generated atypical reduction in purchasing costs of 4-30%. Source: AT Kearncy.

\linÎlllllnl rangé nf :;ayin~s

:\'laxinmm range uf s~lvings

Il"'l)'''1 {-j 'u,

20 25

t

15

t

JO

t

n

Trevol/hotels

Raw materials

eRO

Market research

Llboratory ;:;llpplîes

1

"'0"'0""0" "''',,',' ~ ..,. ~.,~ .Packagl ng -'~. -~,

C vil ÎC1'Cl1ccs/scmill,WS

One company's experienceOne of the top ten phannaceutical com­

panies by sales followed this approach and,over the course of two years, managed torenegotiate more than 50% of its totalexternal expenditure. It achieved world­wide purchasing savings of 10%, theequivalent of several hundred million dol­lars, while maintaining the same level ofquality and service and improving relation­ships with selected prefeITed providers.

Ali areas of expenditure were addressedand generated typically a reduction in pur­chasing costs of 4-30%. Apart from the tradi­tional areas of cost reduction, such as chemi­

cals, packaging, distribution and informationtechnology, sorne cost categories specific tothe phannaceutical industry were targetted,such as promotionalmatetial and advertising,conferences and seminars, and contractresearch and clinical studies (see Figure 3).

ln the area of printed promotional mater-

Scrip Magazine April 199725

cost containment

Local

.Jean-Michel Peny is head of the ph ar­

maceutical practice in t!te Paris office ofthe consulting firm AT Kearney, and alecturer at the HEC and ESCP businessschools Ù, France. Michel Jacob, Senior

Manager, is !tead of the centre of excel­lence in strategic sourcing at AT Kear­ney's office in Paris.

mented, the impact on profits will remainvery limited, no change will be perceivedby selected suppliers and their willingnessto cooperate could be jeopardised for years,putting the business at risk.oThe implementation of a performancemeasurement and tracking system based onboth productivity and internai customer sat­isfaction. Purchasing savings are usuallydifficult to measure and therefore financestaff need to be c10sely involved. Users'satisfaction surveys should be performedregularly to ensure careful monitoring of ailaspects of purchasing performance.

Significant opportunities undoubtedlyexist for pharmaceutical companies to makesubstantial savings in purchasing costswithin a relatively short space oftime. Expe­rience shows that to secure long-Iasting bene­fits, global purchasing projects need to bepelformed jointly with a change manage­ment programme. Focusing only on the re­engineering of the purchasing function willnot provide the company with quick tangiblesavings. Likewise, a stand-alone, one-timesourcing exercise will fail to overcome thenatural tendency to continue business asusual, causing ail achievements to be forgot­ten once the project is over. il]

~ 'Understand and optimise users' requiremen!s• Assis! sourdng category managers in supplier

selection

• Manage local relationship betwccn supplicrs andusers

• Ensure efficient transactions and user satisfaction

• Monitor day-to-day pcrformance

•Central 1 Sourcing catcgory manage~~J r· Site buycrs and procurers

• Define strategies and action plan forsourcing categories

• Negotiate and sclcct preferred suppliers

• Manage oycrall relationsrup with suppliers

• Estahlish targets and cvaluate performance

r------------------- Strategie procuremeHt process --------------1: (4') :i CD jl1easure;lIellf & !i ~d~ l: :, '! :: :, 'l :, '

i Transa~tion i: cxecuhon :l improvemeltt _'i7. !L ..l

Figure 4: The pharmaceutical company's structure and the fragmented nature of its expenditure meant that only acentre-Ied model could hclp to change the culture within the organisation. Source: AT Kearney.

This requires the existence of multifunctionaland multinational teams, which are usuallycoordinated by buyers.°A pragmatic and systematic approach toachieve tangible results in order to avoid the'study syndrome'. Sourcing teams shouldthus draw up clear objectives in terms ofproductivity and quality improvements, andproject deadlines. An appropriate incentivesand reward system for the best performingteams should be put in place.opermanent support from top management.This ensures that the necessary resourcesfrom business units are available for projectimplementation. It is also necessary forquick decision-making, since many estab­lished practices (such as make-versus-buyissues and human resources policies) willneed to be challenged, often requiring toplevel arbitration.oThe 'buy-in' of users in sourcing deci­sions. Firstly, there should be constantcommunication and promotion of the pro­ject throughout the company, using variousmeans such as interna] newsletters, presen­tations or forums with major stakeholders.Secondly, formalised and systematic vali­dation by users of aIl sourcing recommen­dations and decisions should take place ateach critical milestone (sourcing strategies,shortlisting of suppliers, negotiations) totake into account site specifies, eg de!iverytime, differing quality standards, etc.oThe right purchasing organisation in place,requiring re-engineering of existing struc­tures and the recruitrnent of high calibrestaff. Without it, improvements generatedat team level will not be correctly imple-

through a centre-Ied model (see Figure 4).The mode! he!ped to change the companyculture by building a cross-functional, cross­divisional and truly global organisation.

Within such an organisation, an attractivecareer path needs to be created to attract andretain staff with functional expertise, who areable to negotiate at a strategic level with sup­pliers and who are credible in front of users.The company in question, for example,reacted by recruiting marketing and R&Dpeople with purchasing expertise. It also madea significant investrnentin staff training.

Procedures and information systemswere redesigned according to the new pur­chasing princip les, based on the selection ofsuppliers and long-term contracts. Once ailcontractual conditions have been agreed,preference should always be given to thoseprocedures and systems which allow theuser to interact easily with suppliers, with­out generating excessive paperwork. Buy­ers can thus move away from the traditionaladministrative tasks and focus on the man­

agement of sourcing and suppliers, whileusers have streamlined access to suppliersfor the fulfilment of their day-to-day needs.

Key suc cess factorsThe success of such a project relies

more on the proper management of itslaunch and deployment than on the puresourcing methodology. To achieve this,eight key requirements need to be fulfilled.There should be:

°Fast delivery of improved purchasing valueeither through a 'quick hit' approach or a pilotexercise. 1l1is gives credibility to the project,demonstrates its value and justifies the inter­nai resource requirements for future waves.oGlobal coordination with appropriate syn­chronisation of the sourcing effortsbetween different regional teams (forexample, in Europe, the US and Asia). Thiscoordination can vary from experiencesharing (eg, in the areas oftools/techniques,practices, know-how) to collaboration oversupplier selection in order to enhance thecompany's global purchasing power. Themore global the suppliers' markets and pur­chasing needs, the stronger the global coor­dination should be. For example, chemicalraw materials and information technologyare global categories, whereas packagingand advertising materials are regionally dri­ven categories.oThe right level of resources through closeinvolvement of ail company functions, notjust purchasing. Such a project cannot suc­ceed if it is only a 'buyer's project'. Users'demands need to be chal1enged, and techni­cal and other qualitative criteria must be inte­grated when selecting preferred providers.

26 Scrip Magazine April 1997