Forestalling the Tax Man
For US-based pharmaceutical companies, one of the largest factors keeping manufacturing in-house is the ability to realize
significant tax savings by locating production in tax-advantaged locations. Firms aren't building plants in Puerto Rico, Ireland,
Switzerland, or Singapore because of the weather. The main motivation to choose these comparatively high-cost locations is
reduction in taxes—from the US federal statutory 35 percent rate to 2 to 10 percent in other countries. Companies like Pfizer
have sliced their tax bill in half thanks to Puerto Rican and Irish operations. (See "The Tax Man Cometh").
The Tax Man Cometh
Some firms are looking to reap similar benefits by setting up contractual arrangements with third party manufacturers instead
of owning bricks and mortar. In general, however, these deals are more complex and less time-tested than direct ownership.
Smaller, virtual pharmas may be better positioned to leverage these structures given that the full benefits available from
ownership are less possible.
Benefiting From Third Parties
Although there are many benefits of having internal manufacturing operations, strategic use of third party manufacturers and
packagers also can be beneficial. One key benefit is access to technologies that a company does not currently possess, such
as hard-gel liquid capsules, or challenging product requirements such as highly potent drugs needing high-containment operations.
Instead of building the internal capability to handle such products, pharmas can rely on a contract manufacturer. Then, should
the product fail, a company will have avoided the significant expense of building and validating a specialized capability
only to have it sit idle.
Flexibility to meet changing volume requirements is another reason companies outsource. Contract manufacturers make investments
for more than one client, which spreads risk. These arrangements help companies handle surges in capacity requirements without
tying up assets during slower periods. In some instances, a pharmaceutical company will turn a plant over completely to a
supplier, eliminating the need to absorb the overhead of idle facilities and staff. Should the plant close, the supplier,
rather than the pharma, carries the onus of layoffs or a shutdown. This is especially useful in European countries that have
tied pricing and approvals to in-country employment.
Cost reductions are another reason to consider outsourcing. The recent drought of new drugs means that firms must look closely
at cost and asset utilization. As in other industries, the value of vertical integration is increasingly in question, as best-of-breed
companies show they can outmaneuver their larger, more fully integrated competitors. Therefore, the cost of maintaining all
of one's own production and packaging facilities compared to outsourcing some operations to focused companies may not be supportable
to the investment community. The challenge is for companies to compare the true cost of making their own products on an apples-to-apples
basis with third party alternatives, and strike the right balance between internal and third party manufacturing. (See "The
The Whole Cost
The Question of Balance
A framework for performing this analysis includes the dimensions of product life cycle, product technologies, tax situation,
availability of third party capabilities, and the existing internal manufacturing footprint. Applying this framework will
enable a firm to identify the best approach, whether fully insourced, fully outsourced, or somewhere in between.
Across the Lifecycle Demand requirements are least certain early in the product lifecycle. The choice is whether to build internal capacity to
handle optimistic forecast levels, or to utilize a combination of internal and external capacity. This is where utilizing
platform technologies pays off. The law of large numbers will result in more predictable levels of demand across a wide range
of products. In addition, contract manufacturers can provide a backup option for products that utilize readily available technologies.