John Bath, chief executive officer of Brecon Pharmaceuticals, looks at the drivers behind outsourcing and how relationships between customers and providers are strengthening with the development of strategic alliances which can bring huge benefits to both parties
The reason for growth in the outsourcing market is in part due to the fact that many larger companies – particularly in the pharmaceutical sector – have consolidated. As a consequence the desire to outsource non-core elements of their business, such as packaging, has increased. Over the same period there has also been the rapid emergence of a variety of smaller companies for whom outsourcing is a fundamental element of their business model.
Even where companies retain in-house packaging activities, today’s increasingly competitive commercial environment has driven most to optimise efficiencies. Consequently, outsourcing part or all of the work to a specialist provider, is being seen an increasingly useful tool.
In a plant with regular work which is ongoing and undemanding, but interspersed with sporadic or smaller run sizes of alternate products, it can often make sense to outsource the latter to maximise outputs of the former. Similarly, using an outsource provider to help deal with periods of peak demand can enable a company to optimise internal performance based on even throughput, leaving the outsource provider to absorb the variation.
Another popular reason for outsourcing is to ‘bridge step’ investments in capital equipment to cater for volume growth. While a first machine may be running to capacity, it will often be sometime before a second unit becomes fully occupied. Additional volume can be outsourced until demand grows sufficiently to justify investing in a new machine.
Some pharmaceutical houses, for example, may only have capabilities in certain packaging formats. But while a product may be primarily sold, for example, in blister packs, there may also be a requirement for strip packs or bottles according to particular market needs. The volumes do not justify internal investment in equipment specifically for these packaging types, but an outsourced provider would be able to offer capacity on existing equipment.
For new product launches, outsourcing can be helpful in two respects. Firstly, internal capital expenditure can be limited to conservative forecast demand, with the contingency of excess demand being absorbed by the outsource provider, thereby minimising the risk of stock-outs after launch.
Secondly, as patent protection periods effectively decline, speed to market is increasingly important in the pharmaceutical sector. Utilising outsource providers can offer pharmaceutical houses additional capacity to enable more rapid build-up of launch stocks.
Finally, many companies have developed risk management strategies, and recent events have served only to reinforce the necessity for these. An outsourced provider with tooling in place and a validated process can be a comforting reassurance should calamity strike at the company’s primary site.
The outsourcing relationship
As the outsourcing industry matures so does the nature of the relationship of the outsource provider with the customer.
In the early days of outsourcing, the outsource provider was seen primarily as a backstop or fallback – a resource to be used only when an internal system broke down or became over stretched. In this ad hoc relationship, a number of factors characterise the way in which companies work together.
By its very nature, the decision to outsource is based on expediency. Such a decision is probably invoked when demand is unpredictable, sporadic and, more than likely, urgent. Because of the unpredictability, there are often short-notice changes to requirements – for example, the need to make more, to make less, to do something different, or even to stop.
In the ad hoc relationship, the outsource provider seldom has the opportunity to optimise processes or labour utilisation. The work arrives one day, is gone the next and there is no reliable indication as to when such work will return. An outsource provider therefore will cope as best as it can with the tools immediately at its disposal to satisfy the urgent requirements of the customer.
Such ad hoc outsourcing is, and will continue to be, a significant proportion of the outsource provider’s work mix. However, many companies are moving towards a more strategic view of the concept.
In a strategic relationship, outsourcing becomes an integral part of a plan where the declared intention is to outsource some, or all, of the work. In such cases the outsourcing relationship is more likely to last throughout the life cycle of the product and the requirements of the work are generally more predictable.
When outsourcing becomes an inherent part of the business model for the development of a particular product, a project team will usually be established comprising representatives from both the company and its outsource provider. This team will represent the supply chain, quality and regulatory elements of the relationship.
In developing such a team, deep and broad relationships can grow between the two parties. There is a commonality of purpose and considerable time and effort is expended on creating the best solutions and procedures. A variety of personnel from each party inevitably work together to provide the range of skills required to handle all aspects of the job.
Interestingly, because of the longer-term nature of the strategic relationship, there is an incentive on both sides to optimise processes and labour utilisation. The more predictable and repeatable nature of the work encourages greater innovation, which can provide improved outputs, lower costs or both. This move towards more strategic relationships leads to a win-win situation for both parties.
Questions of concern
“Time invested in drafting a contract, which crystallises the goals and ambitions of both parties, is time very well spent”
Brecon Pharmaceuticals chief executive officer John Bath
As beneficial as an outsourcing relationship can be for a company, it is natural that companies unfamiliar with such an approach should voice concerns before venturing forward.
The first question usually raised is that of confidentiality. Naturally a Confidential Disclosure Agreement should be signed by both parties but the bond which secures true business partners extends far beyond a piece of paper. A contract provider must be assured that the outsource partner can satisfy all requirements and maintaining confidentiality is absolutely essential. Trust is earned over years and lost in seconds – an outsource provider who cannot be trusted has no future.
Often companies can wrestle with the question of whether outsourcing is genuinely a cost-effective option. While situations can only be judged on their individual merits, it is important that a holistic view is taken on this subject. On occasions when considering ‘make vs buy’ decisions, a company will choose to ignore, or under-estimate, overheads that should realistically be allocated to their operation. The outsource provider has no such option. Equally, depending upon the initial driver for outsourcing, proper account must be taken of the ‘opportunity benefit’ of factors such as liberated capacity, enhanced internal efficiencies and deferred capital expenditure.
Loss of in-house skills is often another concern expressed by companies when they are considering outsourcing. This is a valid concern, particularly when the entire operation is to be outsourced. However, experience suggests that this need not be a serious issue – a responsible outsource provider who values a long-term customer relationship will always be prepared to share details of best practice or help with the process of bringing production back in-house.
Finally, in the pharmaceutical sector in particular, companies can sometimes be concerned about a perceived loss of control in key areas such as quality, service and regulatory compliance. These issues should be clearly addressed through a well drafted contract, a comprehensive audit protocol and agreed and regularly reviewed key performance indicators. It should be borne in mind that it is in the outsource provider’s own interest that a customer is fully confident that all processes are under control. To this end a responsible provider should be very forthcoming when discussing details of key issues such as training programmes and validation protocols.
Time invested in drafting a contract, which crystallises the goals and ambitions of both parties, is time very well spent. Although the contract itself is of course important, it is the process of drafting it that holds the real value. During the preparation, representatives from both parties will participate in detailed discussions that essentially describe what they are setting out to achieve and what to do if things go wrong. Importantly, it will be during these discussions that any value or cultural divergences will inevitably emerge. Such differences may not matter much when all is going well, but could prove pivotal during more demanding times.
A good contract should state each party’s needs clearly and unambiguously, and should typically include security and confidentiality,regulatory compliance, liabilities, performance, costs and prices.
There should be equally clear statements about appropriate solutions in the case of potential breaches. We find it particularly helpful to challenge the contract with ‘what if?’ type questions to satisfy ourselves as best we can where responsibilities lie in any given situation.
Open book costing
The current outsourcing market suggests a trend away from ad hoc outsourcing relationships and towards strategic relationships. As these strategic relationships mature, and particularly
as both parties look for shared efficiency gains and cost reductions, it is not unreasonable that the customer should request that the costs of the outsourced work should be available for shared scrutiny.
This style of open book costing can be seen as the real test of a strategic relationship. In such an arrangement, the outsource provider offers its customer details of the calculation of its selling price based on the cost of materials [including handling fees], cost of labour, allocation of overhead and targeted profit. With these elements understood and agreed, the customer has a level of comfort with the price charged, and can understand the impact future cost changes will have on price.
The concept of open book costing is easily said but in actual practice, negotiations around it can severely challenge a relationship. For example, there may be disagreement about key efficiency parameters, such as output speeds and labour requirements. The parameters might be perceived as too cautious by the buyer or too ambitious by the seller. The buyer may use this privileged information to try to drive down the seller’s margin or to claim for themselves all the benefits of a cost reduction programme.
Underscoring trust and commitment
A strong strategic relationship will take such debate in its stride and will emerge all the stronger for the effort. When working well, open book costing underscores the trust and commitment already in the relationship. It clarifies the cost and therefore the price and impact of decisions taken by either party. It also provides an unambiguous model for price increases and decreases and prompts suggestions for efficiency improvement, with a logical calculation of the financial rewards to be gained.
After many years in the outsourcing industry, our experience shows that deeper, longer-term relationships maximise strategic benefit for both parties. It is people that make it work – contracts, once agreed and signed, should be put in the drawer. Productive partnerships require an investment of management time in an environment of mutual trust and respect – but the returns on that investment are considerable.