Manufacturers - Purdue University

The Unexpected Impact of Information-Sharing on US
Pharmaceutical Supply Chains
Leroy B. Schwarz and Hui Zhao
Krannert School of Management
Purdue University
To examine the impact of the introduction of Fee-for-Service
and Inventory-Management-Agreements (FFS/IMAs) on
pharmaceutical-distributor inventories and pharmaceutical –
manufacturer inventories. This change:
 Obligated distributors to hold much less inventory
 Provided “downstream” information to manufacturers
 Background: Pharmaceutical Supply chain
 The impact of FFS/IMAs on Pharmaceutical distributors
 The impact of FFS/IMAs on Pharmaceutical manufacturers
4 Major Players in Pharmaceutical Supply Chains
Providers: Clinics, hospitals, groups of hospitals, or Integrated
Delivery Networks
Distributors: Also called “wholesalers”. Nearly 80% of all
prescription drug volume flows through distributors.
Group purchasing organizations (GPOs): They negotiate prices
that its “provider-members” pay for the manufacturers’
products purchased “on contract”.
The Pharmaceutical Supply Chain
Characteristics of Pharmaceutical Manufacturing
 International in scope
 In the U.S., the 10 largest pharmaceutical manufacturers
account for approximately 60% of sales
 Brand-name manufacturers experience high profit
 Ex: Between 1995 and 2008 the top-5 manufacturers
had an aggregate profit margin of 18.5%
Characteristics of the Pharmaceutical Distribution
 Highly consolidated
 Top three pharmaceutical distributors take over 90%
market share.
 Very slim profit margins
 Virtually no profit from downstream
Margin has to come from upstream; i.e., from
pharmaceutical manufacturers
Average Annual Percentage Change in Manufacturer Prices for
Widely-Used Brand-Name Prescription Drugs
The “investment-buying” model
Secondary market
Major Source of Margin: Manufacturer Price Increases
Issues: Volatility, Financial Risk, Secondary Market, Lack of
Transparency and no information sharing
Shift in Business Models
 The end of investment buying
 Catalyzed from a SEC (Securities and Exchange
Commission) investigation of BMS for channel stuffing.
 Settlement with SEC to announce BMS’ limiting future
sales based on demand
 Many manufacturers followed
 The business model of healthcare distributors was
transformed during 2002/2003
 “Investment buying” model (before 2002)
 “Fee-for-service” model (after 2003)
The Fee-for-Service Model
Major Source of Margin: Distribution and Information Services
Provided by Distributor to Manufacturers
More Downstream Visibility for Manufacturer
The Fee-for-Service Model (Cont.)
 Days of on-hand inventory (DOH): Inventory targets (i.e.,
days of supply) with corresponding fees charged to the
manufacturer. The lower the distributor’s inventory, the
higher the fee it collects from the manufacturer.
 Service-level targets: There are usually a few levels of these
targets with corresponding fees. Generally, manufacturers
are charged higher fees for higher service-level compliance.
 Fees for Data Provided. Four major pieces of information
provided to the manufacturers.
Data Provided by FFS/IMAs
 Inventory (on-hand, on-order, etc.)
 Sales/shipment data
 Demand forecast on a rolling basis.
 Theoretically, a distributor should charge higher fees for
providing a better demand forecast.
 Errors in processing charge-backs
Under FFS…
 Distributors now receive margin from the manufacturer,
for their service!
 Transparent information, which should be useful to the
manufacturers in managing their own inventory!
Data for Research
 Financial Information from the Top-3 distributors
(AmerisourceBergen, Cardinal, and McKesson)
 M3 (US Census Bureau) data on US pharmaceutical and
medicine manufacturing inventory dollars and shipment
 Annual surveys conducted by the Healthcare Distributors
Management Association (HDMA).
 Interviews of one dozen pharmaceutical supply-chain
 FFS/IMAs have had a profound effect on pharmaceutical-
distributor inventory, and it appears that this occurred in
two steps
 First, 2003-2005, in order to operate with less
inventory, distributors were obliged to improve their
business processes
 Second, 2005-2009, these improved business
processes facilitated further reductions in distributor
Annual % Changes in Revenues and Inventories
at Top 3 Distributors
Distributor Fill Rate and Reasons for Inability to Ship
Inventory Turnover at Big-3 Pharmaceutical Distributors
Inventory Changes and Savings at Big-3 Distributors
 FFS/IMAs have evidently had no effect on pharmaceutical
manufacturer inventory-management practices
 In the short run, before manufacturers had the chance to
take advantage of information provided by FFS/IMAs,
theory suggests that manufacturer inventories should
either increase or decrease, the net effect depending on
the magnitude of some opposing influences.
 In the long run, once manufacturers have been able to
take advantage of information provided by FFS/IMAs,
theory would predict a decrease in manufacturer
Inventory Turnover at Pharmaceutical Manufacturers
(source: US Census Bureau M3)
Inventory Changes and Opportunity Losses at Manufacturers
Supply-Chain Inventory Changes and Savings
Are Pharmaceutical Manufacturers Using the
Information for Other Purposes?
 Some use it on an aggregate basis to forecast quarterly
sales for financial purposes
 Some use it to monitor inventories at specific large
providers and retail accounts for sales/promotional
Why Aren’t Manufacturers Using Information to Reduce
Own Inventories?
 Manufacturing supply chains are long and complex
 Often long processing time at each step
 International manufacturing network
 Large fixed batch sizes
 Lack of knowledge about how to use
 Not on their priority list
• There are many reasons why manufacturers are not using this
information to reduce inventories and increase inventory
• But, we believe that manufacturers either don’t understand
the potential of downstream information to reduce
inventories, or that they don’t care
 This work examines the introduction of information-
sharing into the supply chains for pharmaceutical products
in the United States.
 This introduction was unusual for several reasons.
 First, it was catalyzed from outside the industry, by SEC
investigation into improper financial reporting by a single
 Second, it was initiated by pharmaceutical manufacturers in order
to keep distributor inventories low.
 Third, although its effect on pharmaceutical distributors has been
profound, evidence indicates that information-sharing has had
little impact on manufacturers' own inventory-management
 Healthcare-product supply chains seem to be unfamiliar
to many supply chains researchers.
 The manufacturing supply chains are very complex  lots
of opportunities for learning and research
 Lots of opportunities for research on the distribution side,
 Supply-chain design
 How should information provided by IMAs be used?
 Leroy B. Schwarz: [email protected]
 Hui Zhao: [email protected]

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