Ways to Recover Lost Margins

Recovery audits and other best practices in procurement can improve the bottom line.
Apr 01, 2012
Volume 25, Issue 4

Gregg Brandyberry
The past 15 years have witnessed extreme and mounting cost pressures on the pharmaceutical industry. This phenomenon has been driven by a host of changes, including:
  • More costly and less productive R&D
  • A saturated North American market where only a few new high-priced/high-margin drugs come to fruition
  • Longer and more costly regulatory cycle times with greater drug-failure rates
  • Advancing generic-drug competition and shorter patent life
  • Outdated cost structures still laden with excess capacity and high-wage/high-benefit employees (although the industry has done much to change this through plant sales and layoffs).

Few can argue that the golden years of the pharmaceutical industry with high-margin products and regular new blockbusters coming into the market to replace products going off patent are over.


Although there is sales growth in exciting new global markets, these markets simply cannot command the high-priced drugs of the past. Granted, the potential exists for significantly increased sales volume over time, but the increased sales will be at a lower price and at lower margins.

To counter these trends, Big Pharma has aggressively deployed network rationalization strategies, other restructuring, outsourcing, and reorganizing, which have resulted in massive layoffs. Reducing infrastructure and operational costs has become the new norm within the industry. Some doomsayers are even predicting the demise of Big Pharma in the decades to come as there will no longer be a financial model that is attractive to investors. Now that may sound a bit farfetched, but one thing is certain: every function and every person is being called upon and challenged to become lean, to cut costs, and to do more with less.

I've written many times in the past that adopting best-practice procurement methods is a great way to reduce costs and to recover margin. My experience has shown that when the right sourcing strategies are deployed and the maximum amount of spend is truly competitively bid, the resulting savings can range from 10–30% of the starting baseline pricing of a company's total third-party purchases. Additionally, if a company is willing to focus on specifications, requirements, demand, and consumption, especially when buying indirect goods and services, significant incremental savings can be achieved on an ongoing basis.

An example of the resulting margin improvement (i.e., recovery) from a best-practice procurement-transformation initiative is as follows. Take the case of a company that generates $20 billion in annual revenues and has total costs for third-party purchases (both direct materials and indirect goods and services) of $8 billion annually with gross margins of 33% (i.e., $6.67 billion). If a company reduced its costs by 10% (i.e., $800 million), its gross margin would increase to $7.47 billion, or a gross margin gain of 12%. If a company reduced the cost by 15%, the gross margin gain would be 18%.

Based on this example, it is clear that a transformed procurement organization is a strong investment. It also should be noted that when done properly, the transformation can be accomplished at net cost post initial investment. Some organizations are even lowering the overall cost of procurement through the use of innovative technology and outsourcing strategies and are seeing a sharp rise in procurement's return on investment.

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