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Better strategies and practices in sourcing and procurement can contribute to the bottom line.
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.
Once spending is properly segmented, four focal points determine the price paid. A company's strategy affects its ability to pay less, to use less, to use something else, or not to use at all. Take a close look at specifications and carefully review the requirements. In many cases, a company will find individual requirements that are "over spec'd" or not needed at all, which lead to significant and unnecessary costs. Additionally, consumption can often be reduced by making the user community aware of the total costs involved and by policies that control overall usage, particularly for indirect items and services.
Online reverse marketplaces. Think about how a company buys. It is probably one of the following scenarios. The simplest is calling the supplier and accepting the price being quoted. Then there is the "haggle" method, same as the first method, but with some pressure applied to get a lower price. Then more sophistication with the "competitive bid policy," in which the buyer typically gets three bids before making a selection. Another method is to do additional negotiation after getting the three bids, an interesting approach, but it still may fall short in securing the best possible terms.
A reverse auction, a transparent and dynamic bidding model, is different. All sellers are bidding on the exact same item or service. When using this method, the buyer must have good specifications or requirement documents available to all sellers as opposed to the haphazard way requirements are given using some of the other traditional methods. Because the buying event has great transparency, sellers can see if their pricing leads or lags. The buyer does not have to select the lowest bidder and may weigh other factors in the purchasing decision. Reverse auctions drive pricing to what the market will bear at any given time against various seller independent variables.
Until recently, the technology required to conduct reverse auctions was costly, required considerable employee training, and presented certain internal and some external barriers for implementation. These barriers, however, are eroding. The premier reverse auction marketplace, FedBid, used by the federal government for 10 years, is now available for commercial use and offers a procurement model for commodity products and basic services. The marketplace has over 50,000 qualified suppliers. More than 50,000 "buys" were conducted in 2010 with savings ranging between 5 and greater than 50%. There is no cost to the buyer for using the technology, which is web-browser-based. The winning seller pays a modest 3% transaction fee and is billed by the marketplace operator 60 days after the buying award is made. If the product is not currently in the marketplace, the marketplace operator will, at no charge, find the right sellers and even train a company's existing suppliers so they can compete on a regular basis in the marketplace. Reverse auctions can be good for buyers and sellers. Buyers save money, and sellers gain more opportunities to win business. Reserve auctions, along with the other sourcing practices discussed, are potential drivers for value creation.
Gregg Brandyberry is CEO of Wildfire Commerce, and senior advisor for A.T. Kearney Procurement and Analytic Solutions, tel. 215.327.5739, email@example.com.
1. E. Teichert, "Top 10 Pharma Layoffs for 2010," FiercePharma, Dec. 7, 2010.