Supply Chain Benchmarking Data Reveals Differences Between Pharmaceutical and Medical Device Manufacturers

Gartner’s supply chain metrics benchmarking program now identifies key differences between medical device and pharmaceutical manufacturers, and highlights how trade-offs are being made. Supply chain leaders in both industries can use this research to improve supply chain strategy and goal setting.

Overview

Key Findings

• For the first time, Gartner’s benchmarking metrics examine pharmaceutical and medical device manufacturers as two different sectors. This particular research looks at customer fulfillment, inventory and costs.
• According to the most recent update to Gartner’s supply chain metrics benchmarking database, fast shipping and transit times in both pharmaceutical and medical devices indicate that companies are likely functioning in a “we’ve always done it this way” manner, instead of building agile and efficient supply chains.
• High inventory levels are frequently referred to as an example of low supply chain maturity in the life science industry. Gartner’s benchmarking program displays finished goods inventory as a percentage of revenue, as opposed to the more typical comparison against cost of goods sold. This portrays inventory as an enabler of revenue and profitability, and shows both life science industries in line with other industries.

Recommendations

Supply chain leaders responsible for strategy and governance in life sciences should:

• Analyze relationships between supply chain functions, such as inventory and fulfillment by using tools like Gartner’s supply chain benchmarking program. Calculate and communicate the shared business impact of change prior to implementing new programs.
• Use Gartner’s Hierarchy of Supply Chain Metrics to spark discussion among internal stakeholders about ways to align goals, like those for cost, service and inventory.
• Evaluate key processes using Gartner’s benchmarking program. Use these tools to balance supply chain processes against business goals and customer expectations.

Analysis

Gartner’s supply chain benchmarking study provides an opportunity to compare the performance of supply chains on a number of key supply chain metrics across different industries.¹ This industry comparison is the basis for this research.

This research gauges the performance of separate populations for both pharmaceuticals and medical devices. We evaluated the performance between industries using the benchmarking data by comparing the median and third quartile values of the industry populations. The differences in performance and trade-offs are distinct.

Every life science supply chain can benefit from an external benchmarking exercise as it strives to become more customer-focused and efficient. When Gartner last looked at life science metrics in 2016, the data combined both medical device and pharmaceutical manufacturers into one industry segment called “life sciences.” Over the past three years, enough data has been collected to make the segment populations statistically significant.

For the first time, this research breaks out both industry segments separately, offering key comparisons between pharma and medical devices, as well as versus other industries. Specifically, this research drills down into customer fulfillment metrics, inventory and cost.

The methodology behind Gartner’s supply chain benchmarking program is designed to assess a comprehensive framework of end-to-end supply chain performance, instead of a collection of isolated, individual metrics.

Gartner’s benchmarking program is based on the Hierarchy of Supply Chain Metrics, a set of 18 metrics that measures the end-to-end, demand-driven supply chain. (See Figure 1.) The Hierarchy identifies the interdependencies and trade-offs between various metrics at strategic, working capital and operational levels (see  “The Hierarchy of Supply Chain Metrics: Diagnosing Your Supply Chain Health”).

The multilevel approach allows supply chain leaders to evaluate their organization’s performance based on intended outcomes, as well as to account for any segmented service response requirements. It also allows them to align their metrics top-down (strategic to operational) and horizontally (across functions), creating a connected framework that holistically evaluates supply chain performance.

Customer Fulfillment: Strengthen Ties With Downstream Partners

Both the medical device and pharmaceutical segments operate with fast shipping times and order cycles, indicating that a reliance remains on the classic supply chain strategy of stock availability and quick response. This approach persists in both pharmaceuticals and medical devices because long manufacturing lead times and slow change management don’t lend themselves to a more just-in-time or agile response. Another factor contributing to the popularity of the “ready to ship” model is that demand planning at downstream supply chains is not highly sophisticated, often relying on fixed reorder points and case quantities to determine order frequency and volumes.

While this fulfillment approach continues to work, the landscape is changing. Although healthcare providers carry the image of having lagging inventory management and demand planning capabilities, many hospitals are becoming much more sophisticated in this area. Even so, the life science industry still operates in a “We’ve always done it this way” mode, with the goal of shipping and delivering quickly, regardless of whether the customer needs product in two days or two weeks. As depicted in Table 1, the upper quartile of performers in both sectors ships product in just over 24 hours from order. Order to delivery times in the upper quartile of both segments is just under three days.

In general, life science manufacturers put a lot of effort into shipping product quickly, which represents a myopic, siloed view of how the industry works. In many cases, customers are not operating in a just-in-time fashion, like delivering medical devices direct to operating rooms for immediate use. Although urgent needs do occur in specific situations, this fulfillment model, using extremely fast order-to-delivery cycles should be a stand-alone, limited-use supply chain segment.“Quick twitch” fulfillment response is especially surprising on the pharmaceutical side, where wholesalers serve as inventory buffers, managing their demand and making independent inventory decisions to protect against out-of-stocks. Retail and hospital pharmacies also maintain their own inventories, so there are multiple inventory buffers between the manufacturer and the patient. Pharmaceutical wholesalers represent a vital component of the drug supply chain. By holding stocks of vital medicines, full-line wholesalers add an extra layer of safety stock into their supply chains, benefiting both manufacturers and patients. It should be rare for pharma to need to urgently ship to address an out-of-stock situation or get product directly to patients. However, a lack of visibility and orchestration across the multiple entities involved in getting products to patients inhibit progress toward this ideal.

Opportunities abound for pharmaceutical manufacturers to increase their involvement in downstream distribution channels, especially in the areas of logistics, collaborative demand planning and analytics. Manufacturers should explore collaboration opportunities with channel distributors that have invested in diversified services that simplify logistics operations, improve product availability through collaborative demand planning and offer market insight through powerful analytical platforms.

Medical devices and pharma should work with downstream partners to identify ways to improve demand management and inventory visibility opportunities. For example, do all your products need next-day delivery? By working with trading partners, can you segment and have 90% of volume switch to five-day transit time, with only critical items shipping faster?To advance customer fulfillment further, explore opportunities like:

• Progress the maturity of demand planning, from reaction and prediction to sensing and shaping.
• Implement forward stocking locations for situations when demand planning can’t progress beyond reaction. Locating inventory closer to customers reduces the time and cost of transportation.
• Work with downstream partners on ways of collaborative planning.

Pharmaceuticals and Medical Device Segments: Key Differences

Although order to ship and order to delivery are very similar for the two industry segments, metrics for on-time in full reveal a variance of about 300 basis points, with the median for pharma at 93.7%, versus 90.8% for medical devices. There is no obvious conclusion for this difference, considering that finished goods inventory levels and demand forecast error are similar. When considering how life science supply chains operate, it is much more common for medical device manufacturers to ship directly to an end user like a hospital. Pharmaceutical companies have the advantage of inventory at wholesalers and pharmacies to buffer patient demand. Because of this, it would be expected that these metrics should be reversed, with the better performance on the medical device side.Depending on your industry segment, two distinct opportunities arise:

• Pharmaceutical manufacturers: Collaborate across the enterprise to determine if on-time, in-full (OTIF) responses are unnecessarily high, and determine if high service levels are required, given that there is another layer (wholesalers) that ultimately influences service levels to pharmacies and patients.
• Medical device companies: Fully understand the impact of lower service levels and look for ways to improve, be it through finished goods inventory, forecast accuracy, or even more sophisticated supply chain tools that enable demand sensing and better visibility.

Inventory: Use Inventory to Gauge Broader Business Health

When discussing life science supply chains, conversations quickly turn to inventory levels. Because high inventory levels can mask fundamental supply chain problems like inefficient processes, slow responses to change and long lead times, the industry is quickly judged to be “behind the curve” in terms of supply chain maturity.Internally, inventory is the focus of an ongoing “tug of war.” Commercial organizations see it as a way to increase sales. Finance sees it as an impairment of working capital. Supply chain is often caught in the middle. But the life science industry itself sets the expectation for higher inventory levels than other industries, being the ultimate use of the product. Because life science products are used in life-saving and sustaining applications, the benefits of higher inventory outweigh the detriments.

Finished Goods Inventory

Finished goods inventory, as mentioned above, is the primary tool for enabling high service levels for both medical devices and pharmaceuticals segments. Despite the difference seen in OTIF between the two segments, as seen in Figure 2, both the median and the upper quartile values are very close. Forecast error doesn’t explain the discrepancy either — at the median level, there was only a 1.5% difference between the two segments.Especially for the medical device segment, there is likely an opportunity to either realize higher service with the same level of inventory, or reduce inventory and maintain service levels.

WIP Inventory

The likely reason for the higher number in the pharmaceutical segment is the nature of pharmaceutical manufacturing. The average pharma product has three distinct manufacturing processes:

• Active pharmaceutical ingredient (API). This is the bulk ingredient that manufacturers typically make in large batches once or twice a year.
• Final dosage form (FDF). This is where the active ingredient is mixed with excipients into a form ready to administer to the patient (like tablets, capsules and vials).
• Packaging. This final step involves putting FDF into bottles, blister packs and boxes.

These three subtle steps are frequently treated as three distinct supply chains, often with minimal coordination and planning between them. For work-in-process (WIP) inventory, the pharmaceutical segment is again higher, likely due to the many process steps involved in the pharma sector, and the lack of planning between steps. Given the nature of the pharmaceutical industry, it is not surprising to see its WIP inventory higher than for medical devices.

Raw Materials: Large Discrepancies Exist Between Pharma and Medical Devices

When it comes to raw materials inventory, the pharmaceuticals segment has more inventory than the medical device segment at the median, although the gap closes somewhat at the upper quartile. (See Table 2.) Just like finished goods inventory provides a buffer between supply and customer demand, raw material inventory is often a buffer for supplier performance. However, that doesn’t appear to be the case, given the similarity in supplier performance metrics between the two segments.The large discrepancy in raw materials between pharma and medical devices is likely due to the campaigning of API, which typically involves large batches that are made once or twice a year and drawn down as needed. This process usually involves stockpiling raw materials and consuming during the infrequent API campaigns, which, therefore, results in huge peaks and valleys of raw material inventories.

Use Inventory as a Percentage of Revenue

A unique aspect of Gartner’s supply chain benchmarking database is the inclusion of inventory as a percentage of revenue. Typically, inventory is viewed as a percentage of the cost of goods sold as inventory turns. While this is a useful measure to gauge the amount of inventory on hand, it doesn’t consider that some inventory is better than others at delivering revenue and profitability.

When inventory is compared on a revenue basis, inventory becomes an enabler of sales and revenue, which is logical considering the entire purpose of carrying inventory is to avoid lost revenue from stockouts.

For example, finished goods inventory for pharma is 75 days, or nearly 11 weeks of inventory. (See Figure 2.) This number looks high when compared with other industries. High tech, for example, has a finished goods inventory of 30 days, less than half that of pharma. When looking at the value of total inventory, four weeks of inventory in high tech is equivalent to about 15% of sales annually. Interestingly, 75 days of finished goods inventory in pharma is also equal to about 15% of revenue. This means that when comparing inventory to revenue, the playing field is leveled across industries. Although pharma carries 11 weeks of inventory, it is still enabling the same amount of sales as those four weeks of inventory in high tech. Comparing inventory to revenue changes the storyline in pharma from one of being highly inefficient, to one highlighting those 11 weeks of inventory as actually enabling revenue growth and recognizing that the downside of less inventory could mean missed sales, which is magnified by the high gross margins in pharma.

CFOs might be tempted to pressure supply chain executives to reduce inventories by arguing that carrying 11 weeks of finished goods inventory ties up cash flow that can be used for other things. However, the inventory-to-revenue model provides evidence that these levels, compared on a revenue basis, are pretty commensurate.

Inventory Obsolescence: A Sharp Divide Between Industries

One area where pharma shows clearly higher performance is in inventory obsolescence. At both the median (3.7% for pharma, 6.0% for medical devices) and upper quartile (2.1% for pharma, 2.9% for medical devices), the pharmaceutical industry is clearly the better “steward” of inventory.

Although both segments face defined shelf lives for their products, potential explanations for this difference are the size of the average product portfolio and the frequency of new product introductions. Although there may be many dosage forms, concentrations and packaging configurations of products for a pharma company, the actual number of unique APIs usually doesn’t reach triple digits. This makes portfolio management simpler, especially when manufacturing and packaging postponement is used. New product (specifically API) introduction is also less frequent, reducing the pressure.Contrast this to medical device companies, where portfolios frequently contain hundreds if not thousands of active products. New product introductions are also more frequent, which can “steal” demand from existing products. If supply planning is not synchronized to these changes, or overly reliant on historical trends, oversupply may occur, which then leads to product obsolescence.

Forecasting error certainly has an impact on the rate of product obsolescence, as overbiased forecasts can lead to a manufacturing product that doesn’t have demand to consume it. However, the difference in this case doesn’t seem to explain the gap in performance seen here. At the median, the pharma industry is 1,600 basis points better than the medical device industry in demand forecast error, and only 1,100 basis points better at the upper quartile.

Regardless of ultimate root cause, these metrics indicate that many medical device companies are wasting resources producing products that are ultimately thrown away. This wastes manufacturing capacity, consumes warehouse space and adds cost to dispose of the products.

Costs: On Paper, Most Sectors Perform Similarly

When it comes to transportation and warehouse/distribution center costs, pharmaceutical and medical devices perform similarly at median percentages, as shown in Table 3.

The fact that both sectors perform similarly is interesting, given wide variances in go-to-market strategies. This is unlike pharmaceutical manufacturers, which sell to a wholesaler network, medical device manufacturers generally ship to thousands of locations, directly to healthcare providers globally. The transportation costs and handling costs within the warehouse are higher because of that, versus the larger and less frequent shipments pharma makes to drug wholesalers, which require less labor.

An explanation for the divergence at the upper quartile may be related to the profitability of the industry segments. On average, gross margins in pharma average around 70% versus 57.7% for medical devices (healthcare products), according to Aswath Damodaran at the NYU Stern School of Business.² As a percentage of sales, the upper quartile in pharma likely represents more profitable businesses, and as a result, transportation and warehousing costs appear that much smaller.

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