The Sarbanes-Oxley Act—or SOX, as it is dubbed (not always so affectionately)—requires companies to provide greater control
and quality assurance across a vast spectrum of business processes. In practice, SOX plays out differently industry by industry
and even company by company. But for pharma, one of the most pressing consequences is the need to improve the accuracy of
The devil, of course, is in the details. Given the industry's famously fragmented supply chain, achieving precision in revenue
recognition has proved no small challenge for many pharmaceutical companies. Still, however costly and time-consuming in the
short run, the effort is likely to have long-term benefits as e-pedigree tracking and other new initiatives revolutionize
the flow of information upstream and down. Until these systems are up and running, a data-collection and-analysis approach
developed by IMS Health can offer significantly greater insight into the supply chain, enabling pharmaceutical executives
to hit higher levels of SOX compliance.
THE RIDDLE OF REVENUE RECOGNITION
A reaction to such spectacular financial meltdowns as Enron, Tyco, and WorldCom, the Sarbanes-Oxley Act demands that publicly
traded corporations bolster their internal-control frameworks. The goal of the legislation is ultimately to increase the accuracy
of the published financial statements upon which investors base their decisions.
In a way, SOX is less of a stretch for pharma than for other industries. Because quality is so important in drug development
and manufacturing and because the industry is so regulated in the first place, drug makers and distributors already have a
high compliance IQ. In essence, the companies have a culture of control.
Tracking, Tracing, Transponding
However, when it comes to issues of revenue recognition, the industry's much-segmented supply chain can make answering even
the most basic questions seem like a run-in with the Sphinx. Try: When is a sale really a sale, and at what price?
Many factors are responsible for this fragmentation. For example, the industry's business model features large intermediaries
or consolidators, such as McKesson and Cardinal, putting increasing distance between—and wielding increasing influence over—sellers
and buyers. Widespread use of discounting and rebating to shape sales contributes to the uncertainty, as do product dating
and other quality controls. Overall, it is a disparate distribution system ill-suited to precision in revenue recognition.
All of this is causing much grumbling among pharmaceutical executives. A basic Internet search on the subject of revenue recognition
in the industry reveals not only a whirlwind of conferences but also a spike in the number of auditors and firms hunting for
executives with relevant experience. Unquestionably, this is a key challenge for the pharmaceutical industry.
BEST GUESSES NOT GOOD ENOUGH
Against this backdrop, IMS was recently approached by a client facing a number of challenges in achieving full compliance
with Sarbanes-Oxley rules. In particular, this drug maker wanted to restate several years of earnings statements. Its reported
revenue recognition had been based on the commonly used "sell-in" model.
In a typical sell-in scenario, revenue is recognized when the product leaves the manufacturer's factory. (Essentially, the
products are assumed to have been "sold in" to the marketplace.) But in practice, companies must adjust this figure, recognizing
that it does not yet account for a whole host of probable—but often very unpredictable—contingencies.
For example, seller rebates are widely deployed throughout the industry. Though useful as a means of wooing large buyers,
such as managed-care organizations, precise rebate levels complicate revenue recognition because they are almost impossible
to anticipate. The same can be said for the industry's frequent charge-backs, contract-based discounts, returned goods, and