Offsetting Budget Cuts

Better strategies and practices in sourcing and procurement can contribute to the bottom line.
Jul 01, 2011
Volume 24, Issue 7

Gregg Brandyberry
For several years, Big Pharma has been cutting programs and reducing headcount as a result of mergers and acquisitions and overall cost-cutting efforts. According to industry estimates, approximately 50,000 pharmaceutical industry employees lost their jobs in 2010, and 300,000 have been let go in the past 10 years (1). Many reasons are behind these cuts: a decline in traditional research and development productivity, tougher regulatory hurdles, a plethora of government and formulary pricing controls, and significant patent expiry of major blockbuster drugs.

Now, more than two years post the economic meltdown, the industry understands that prosperity is not around the corner. What many call the "New Normal," characterized by slower growth, tighter credit markets, a more conservative approach, less money available for investment, and tighter financial regulations, has become the new operating reality.

It doesn't have to be all doom and gloom, however. Even in the best-run organizations, there is an untapped source of cash from what I like to call "creating your own stimulus by buying items and services better." In many companies, the cost of purchased items and services (i.e., the money paid to suppliers) is equal to between 30–70% of total company revenue. In the pharmaceutical industry, this cost is typically between 30 and 50%. What I've come to understand is that regardless of how good or how bad a company is at buying products and services, there is still plenty of cash to extract from its costs. Three methods—spend segmentation, better specifications, and online reverse marketplaces—can improve results.

Spend segmentation. By not applying the appropriate sourcing strategy, a company may pay between 10% and as high as 70% more for products and services, based on my experience. This differential exists because of the strategy or lack of strategy that is in place for a certain purchase. There are four types of supplier relationships that may be classified by such attributes as ease of buying, supply-market competitiveness, uniqueness, and strategic importance. These strategies may be defined as "critical," "strategic," "acquisition-oriented," and "leverage-based." A buyer's strategy needs to be in the right category to ensure that a company is paying the right price, producing the right total cost, and getting the best value associated with a particular product or service.

For example, if a company is making a purchase where the supplier maintains the power in the relationship (i.e., "critical"), the buyer is paying an absolute premium. Typically, less than 10% of a company's spend will be designated as "critical", according to my experience. Companies with poor purchasing practices, however, often allow suppliers to act as if they were a natural monopoly. A purchaser should review its spending to move supplier relationships from the "critical" position to "strategic" or better yet to "leverage" positions. My experience suggests that on average, only 20% of spend is truly "strategic," and most of what is purchased can be highly leveraged among multiple suppliers.

Better specifications. Many factors determine how much to pay for a good or service. In simple terms, supply is what is available, and demand is how much is being requested. Consumption is how much is being used at what rate, and specification is what constitutes a product or service. The interactions of these variables are the main drivers of price paid.

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