StreetTalk: Have Business, Will Travel: Outsourcing in the Global Commerce Age

Hey, nobody ever said making a profit in the pharmaceutical market was easy. The barriers to success are both high and numerous. Industry figures show that only one candidate in many thousands ever becomes a commercially viable product. The average commercial drug costs $800 million to research and develop. And less than one-half of all commercial drug products ever return a profit to their parent firms.

And don't get me started on all the legal, compliance, and government clearance issues that biopharm companies must address before even getting out of the starting gate.

Brian O'Connell

Good or bad, depending on your point of view, it's no longer a luxury, but a necessity for biopharm companies to turn to outsourcing these days.

You can't blame the bean-counters — the chief financial officers and other corporate finance executives who make the decision to farm out operations. With the financial risks so high in the biopharm market, more and more companies in the life sciences arena are looking at outsourcing options to effectively reduce some of that risk that is prevalent and unique to the biopharm industry.

In a recent study of global outsourcing by the Chicago-based analyst group DiamondCluster, the growth rates associated with shipping out operations overseas is skyrocketing. About 86 percent of 182 US companies surveyed plan to increase the use of offshore outsourcing firms. 40 percent of buyers expect to outsource some IT functions to China over the next three to five years compared to eight percent last year. And while 88 percent of buyers remain concerned about employee backlash, worries about anti-outsourcing legislation and political pressure have lessened significantly.

The study states that the greatest risks of outsourcing include the increased complexity of managing relationships, reduced operational effectiveness, and lower quality of output from their outsourcing providers. It casts doubt on the return on investment benefits associated with outsourcing overseas, with over one-half of study participants unsure of whether their outsourcing efforts will bear fruit from a financial bottom line perspective. In fact, the number of companies that expect to save big money has dropped significantly. They anticipate outsourcing to save only 10 to 20 percent of their costs, down from 50 percent in 2003.

ON THE OTHER HAND . . .

With such mixed results, why are companies going the outsourcing route?

There are several theories that outsourcing proponents have been advocating for years. While we all know theory is not the same as execution, the prevailing wisdom was that outsourcing would help US firms in three key ways:

• Profits – By farming out tasks that companies don't do well but still need to do, they can then focus on the things they do well, thereby increasing the chances of higher return on assets. Some evidence of that is true. In a study by the Information Technology Association (ITA) of America, US software and technology companies will save $21 billion a year by 2008 through outsourcing, adding $124 billion to the US economy.

• Productivity – Companies that outsource are discovering that the work left behind is usually the work employees are trained to do and enjoy doing. Consequently, personnel productivity tends to rise after outsourcing programs are in place. In the ITA study, researchers found that cost savings associated with global outsourcing increases employee productivity, boosts their wages, and creates 317,367 new jobs over the next five years. That scenario tends to make both employer and employee very happy. "There is one time-honored agreement in economics: free trade produces gains for all parties," says Lawrence Klein, a 1980 Nobel Prize winner and one of the lead researchers in the study. "That is still the case. The American way has always been to move to activities that are higher value-added."

• Politics – Outsourcing can remove many administrative and man-agement headaches asso-ciated with the basic nuts-and-bolts operation of a company. With logistics, distribution, or back office functions farmed out to specialists, companies have free reign to focus on deployment of company resources in areas that need help the most.

OUTSOURCING IN THE BIOPHARM INDUSTRY

Remember, those are theoretical benefits associated with global outsourcing.

A closer look — this time at the biotech and pharmaceutical sectors — reveals that outsourcing has resulted in some of those benefits, but not all.

A thorough — and thoroughly engaging — September, 2004 report on outsourcing in the life sciences sector by Boston-based CFO Research Services involving companies like Bristol-Myers Squibb, Genentech, MedImmune, Genzyme Corp, Endo Pharmaceuticals, and others, indicated that biopharm companies are increasingly bullish on global outsourcing.

"Increasingly pharma and biotech firms are examining the effectiveness of outsourcing as they search for new drivers of revenue and profit growth," the report states. Revealingly, the reports cites upcoming patent expirations ($30 billion of US drug sales at top US pharma companies are at risk from patent expirations by 2007, says CFO Research); pricing pressures (pricing strains will cut $9 billion from top pharma firms by 2007); slowing drug pipelines; and increasingly high costs for research and development as major drivers of outsourcing growth in the life sciences sector.

"Many pharma and biotech firms are more willing to outsource due to increased pressure for profits," the report continues. "They hope to achieve cost savings, revenue growth, and a boost in productivity. Smaller firms seek to stretch limited resources." The CFO study adds that IT, payroll, manufacturing, and clinical-trial data management are key areas for growth in biopharm outsourcing efforts.

On the downside, fear of error by outsourcing providers "in an industry that cannot tolerate mistakes" is a primary roadblock to increased interest in industry outsourcing. Farming key company areas to far off bourses like India, South Korea, or China was cited as another key barrier to growth.

One firm cited in the report that has enjoyed a great deal of success in the outsourcing field was pharmaceutical giant Wyeth, which has outsourced significant portions of its operations including clinical-trials; data management, information technology, finance and accounting, benefits, manufacturing, and payroll. And it might not be done yet.

"As we continue to grow and look for ways to do things better, outsourcing will continue to be an alternative that is considered," Wyeth CEO Kenneth Martin told study researchers. Martins says that, when it comes to outsourcing, Wyeth prefers the piecemeal approach. "We're a company that's been growing and there is a lot that is in constant flux. So we think long and hard before we outsource. Because there are some things that are easier to outsource, we outsource pockets of what we do."

While not as bullish as Wyeth, Bristol-Myers Squibb is considering climbing aboard the outsourcing bandwagon in a big way, too. It's spent the last year searching for a service provider for its information management and financial shared services operations. "What will make us go ahead is getting good, obvious cost-savings with manageable implementation risk," says Andrew Bonfield, CFO of the company. Squibb also prefers to keep things local. Bonfield told CFO Research that due to political and risk management issues, direct offshoring was not in the cards for the company at this time.

COST COULD BE WORTH THE EFFORT

Whether your company decides to outsource or not, the general consensus reached by the CFO Research report and others in the field suggests that cost savings of 20 percent are indeed realistic. That alone should give CFOs reason to weigh outsourcing risks.

And as long as your CFO and other company decision-makers have a clear understanding of how the outsourcing process works; can choose service partners carefully, with financial stability as a key factor; deploy solid management oversight processes; and let service providers know up front what your goals are and what you will and will not accept, outsourcing might be just the ticket for your company.

But know this. Outsourcing partnerships are a lot like marriages. They have the best of intentions beforehand, but they are excruciatingly painful to undo if things go sour.

Realize that going into the relationship, and your chances of success will rise significantly.

Celebrity author and business/finance commentator for CNN and Fox News, Brian O'Connell has written for The Wall Street Journal and Newsweek, 79 Radcliffe Drive, Doylestown, PA 18901, 267.880.3144, fax 267.880.1939, brian.oco@verizon.net