Product Technology Products that utilize unique technologies pose difficult choices. External capacity is unlikely to be available, or may require up-front capital. In these situations, manufacturing leadership needs to engage even more extensively to ensure that marketing forecasts are realistic in light of competitive offerings. Nothing illustrates that better than Pfizer's recent experience with Exubera. The company wrote off $2.8 billion after withdrawing the inhalable insulin, which achieved peak sales of only $12 million. A portion of this write-off was for the unique injection-molding capacity Pfizer had built for Exubera at third party injection molders. A real-options analysis can model the potential outcomes more broadly and identify ways to address optimistic peak forecasts while hedging against the possibility of a bad outcome.

Taxing Decisions Each company should develop a tax strategy in concert with its supply chain strategy. Some Big Pharmas focus on realizing tax savings at the API (active pharmaceutical ingredient) stage, and construct bulk drug plants in a tax-advantaged location. Others choose to realize tax savings in their formulation facilities. The increasing percentage of in-licensed products is prompting companies to rethink their strategies because in-licensed products may not provide Big Pharma with API manufacturing rights, rather requiring them to purchase API from the compound innovator.

Emerging firms must pay particular attention to their tax strategy when they launch products. Many such firms have a tax-loss carry-forward from years of minimal revenue and high development costs. A common mistake is to ignore the supply chain tax strategy until a product is already established. At that point the tax-savings opportunity will be diminished.

One issue internal manufacturing groups have cited as a reason not to outsource is the higher quality standards of internal manufacturing operations. The record does not support this bias. Third party facilities are inspected much more frequently than internal facilities, by both customers and regulatory agencies. While an internal facility that receives an FDA 483 Warning Letter, or even a consent decree, tends to be rewarded with new capital and resources to address the issues, one wrong move can put a contract manufacturer out of business.

The one area some contract manufacturers have been struggling with is maintaining healthy profits. The irony is that they are often accused by pharma executives of charging high prices and achieving excessive profits. This perception stems from the misunderstanding of cost—and the hidden subsidies that internal manufacturing receives in terms of capital access and transfer costs.

The emergence of Indian, and more recently Chinese, suppliers is also having a profound effect on the outsourcing market. Major pharmas are sourcing significant portions of their key intermediates and APIs from Asian suppliers. This trend is expected to accelerate, with India now boasting over 75 FDA-approved plants and Indian sources representing over one-third of all new-drug master-file submissions. However, in the near term, Asian suppliers are less likely to focus on formulation and packaging for branded products. As a global head of contract manufacturing for a European pharma put it, "Formulation and packaging represent less than half the cost of a tablet, and with competitive pricing available in Europe, it's not worth the additional savings to deal with the complexity and cost of managing an Indian supplier."

Baxter's recent recall of contaminated heparin, made at a Changzhou plant, is giving large-cap management pause to review how it monitors its supply chain, especially in China.

A final consideration in evaluating contract manufacturers is assessing financial stability. It's no secret that some of the larger contract service providers like Patheon and Catalent (formerly Cardinal) have had their share of financial upsets. The future for Catalent is particularly cloudy, as Blackstone, its new private equity owner, looks to squeeze profits from a business whose growth has been stuck in the low single digits.