Revenue Leakage And

Management – Pharmaceuticals

Created By SMS Research

July 30, 2010

Contents

1

2

3

4

Global

Pharmaceutical

Industry

Indian

Pharmaceutical

Industry

Pharmaceutical

Supply Chain and

Leakage

Points

Case Studies

Appendix

5

3

Global

Pharmaceutical

Industry

1

Global Pharmaceutical Market

643

837

1,025

2006 2009 2012(E)

CAGR = 8%

Global Pharmaceutical

Sales in USD Billion

Global Share Of Pharmaceutical Market (2009)

45% 30%

North

America

20%

Asia, Africa

and Japan

Europe

India accounts for

about 1% to1.5% of the

global pharmaceutical

sales

Source: IMS Health

5%

Rest of the

World

Note: Market Size include s sales

from bulk drugs and formulations

Key Challenges In The Global Industry

Challenges

Decreasing

R&D Output

Increasing

R&D Time

and Costs

Increasing

Complexity

of

Distribution

Pricing &

Revenue

Pressure

Increasing

Competition

From

Generics

Biotechnology

Alternatives

Source: Deloitte

Drug Research and Development (R&D) costs have rocketed about

25 fold between 1980 to 2005 while drug development time has

increased 12 fold in the same period

Top pharmaceutical companies such as

GSK, Pfizer, Merck, AstraZeneca etc have been facing increasing

competition from generic drug manufacturing companies in India

and Asia

With strict regulatory approvals, manufacturers are finding it

increasingly difficult to introduce new drugs in the market.

Hence, there is an emerging need to implement lean and flexible

concepts to reduce wastage

In recent years, pharmaceutical companies have been making

massive investments on automation and software solutions in

manufacturing and distribution to reduce revenue leakages

It is estimated that in 2009 the top 120 pharmaceutical companies

collectively lost about USD 11 billion due to revenue leakages

Indian

Pharmaceutical

Industry

2

Indian Pharmaceutical Market

6.3

16.3

19.6

2005 2015(E)

CAGR=12%

CAGR=10%

Indian Pharmaceutical Market Size in USD

Billion

India’s Position in Global Market By 2015 (based on market size in USD Billion)

The industry structure remains highly fragmented, with top ten pharmaceutical companies accounting for only about 35% of total pharmaceutical sales

Currently Tier 1 cities (which includes metros and other major cities with over 1 million in population) account for nearly 60% of the total market while Tier 2

cities and rural areas account for the remaining 40%

It is estimated that in the next decade over 45% of the growth is going to come from Tier 2 markets with implies that efficient distribution is going to be critical for

pharmaceutical companies

Increasing population, rising income levels of households and increasing penetration of health insurance are expected to be some of the key drivers for the rapid

growth of the pharmaceutical market

By 2015, generic products are estimated to capture about 10% of the total market

Source: Mckinsey, Boston Analytics

Key Challenges In The Indian Industry

Source: Multiple Sources

Working Capital Constraints

Export Related Challenges

Lack of Transparency in

Legal Procedures

Decreasing Margins

• High domestic competition especially in the Generic medicines has made

Indian pharmaceutical companies to look to penetrate the untapped developed

markets (for generics) like Japan for growth

• Capital constraints are proving to be a hindrance for Indian companies to

expand to newer markets

• Exports have a significant contribution in the total revenues for Indian

pharmaceutical companies. However, the increasing competition and stringent

country specific regulations are leading to increasing operating costs and margin

pressures

• The legal procedures governing the operation of pharmaceutical companies lack

transparency. Indian pharmaceutical companies have faced lawsuits from multi-

nationals as a result of discrepancies in the grant of EMR (Exclusive marketing

rights)

• There has been a tremendous upsurge in competition for Indian

pharmaceutical companies both at international as well as domestic

front. The increased competition has led to pricing pressures resulting in

decreasing margins for pharmaceutical companies

Challenges Due to TRIPS

• In 2005, India signed the TRIPS (Trade-Related Aspects of Intellectual

Property Rights). As a result the previously existing process patent

legislation as part of the Indian Patents Act, 1970 was abolished

• TRIPS recognizes both product and process patents and these are

granted for a 20 year period

• It is expected that TRIPS will reduce competition for MNC companies

from India drug manufacturing companies in the domestic market

The Prices Of Scheduled Drugs Are Regulated By

The Government

• The prices and margins of pharmaceutical drugs in the Indian market are highly regulated by the Government

through the Drug Price Control Order (DPCO), 1995. The provisions of the DPCO are implemented by a constituted

body called National Pharmaceutical Pricing Authority (NPPA)

• The central government sets the maximum sale prices of scheduled bulk drugs. While fixing the price of a

scheduled bulk drug the Government may take into consideration

• A post tax return of 14% on net worth

• Return of 22% on capital employed

• Internal rate return of 12% based on long term marginal costing

• If the production is from basic stage, the post tax return is 18% and a return of 26% on capital employed is

provided

No person can sell a drug at a price higher than the one fixed for it including the local taxes

Overview

• The Union ministry of chemicals and fertilizers has initiated a move to bring all essential medicines sold in the

country under a price cap

• This legislation if implemented will give the drug price regulator, National Pharmaceutical Pricing Authority

(NPPA), the power to control prices of about 17,000 packs of 354 drugs named in the National List of Essential

Medicines (NLEM)

Expected

New

Legislation

• Government fixes the retail price of Scheduled formulations using the formula

R.P. = [M.C.+ C.C.+ P.M.+ P.C.] x [1+MAPE/100] + E.D.

Where: R.P= Retail Price, M.C= Material Cost, C.C= Conversion Cost, P.M= Packaging material Cost, P.C=

Packaging Cost, MAPE= Maximum Allowable Post Manufacturing Expenses, E.D= Excise Duty (where applicable)

• The manufacture cannot increase the prices set by the government. In case he is not satisfied with the price he

may re-appeal for the revision of price

Retail Prices

of

Formulations

• Scheduled Bulk drugs (or API‘s) are those that are indentified and listed in the DPCO. These include key life saving drugs and constitute a majority of the pharmaceutical

market. Scheduled formulations are drugs that use an API listed in the DPCO

• For non scheduled drugs companies can set market prices

• For drugs (formulations and API’s) that are exported, companies can set prices according to local market the drug is exported to

Source: NPPA

Pharmaceutical

Supply Chain and

Leakage Points

3

Pharmaceutical Value Chain & Leakage Points

Source: Datamonitor

Suppliers/ Global

SourcingEnd Customers

Manufacturer

Formulations Value Chain

Bulk Drugs Value Chain

• Chargebacks

• Rebates

• Concealed Shortages

• Customer Segmentation

• Freight charges

• Product Pricing

Flow of payments

Note: This is a generic illustration of the pharmaceutical

supply chain.

Revenue Leakages does not include losses due to

counterfeit and loss of goods during transportation

Patients

Hospitals

Pharmacy

Mail Order

Dr. Office

API Supplier

Excipient Supplier

Pharmaceutical

ManufacturerWholesalers Distributors

Manufacturer Wholesalers Distributors Retailers

End Customer

• Procurement Leakage

(raw material costing

and pricing)

• In addition, fraud leakages occur

across the supply chain due to lack

of proper processes in pricing and

distribution of products

Flow of drugs

Key Revenue

Leakage Areas

Leakage Points

Key Leakage Points In The Pharmaceutical

Industry Are In Logistics and Distribution

Pharmaceuticals

Manufacturing CompanyEnd Customers

(Patients)

Wholesaler Distributor

Retailers

(Pharmacy/

Hospitals etc)

Flow of payments

Flow of Revenue

Leakage

• Chargebacks- Chargebacks—the difference between the price at which product is sold to wholesalers, and the sometimes lower

price negotiated with end customers like PBMs or GPOs, must be reconciled with the wholesaler

• Rebates & Returns - Rebate errors, occur mainly due to a lack of standardization, or improper use of standardized

codes, between manufacturers and managed-care organizations

• Concealed shortages - Caused by customers claiming that orders were only partially filled, then seeking to make only a partial

payment for the order

Chargebacks Rebates & Returns Concealed Shortages

Source: IDC

Pharmaceutical firms lose about 4.4% of their annual

revenues due to leakages in the supply chain

Source: IDC

Chargeback Rebates and Returns Concealed Shortages

Causes of Chargeback Discrepancies

• 12% of chargebacks are

flagged, of which one-third are

resolved without resubmission

• Of the remaining 8%, half are

resolved upon resubmission

• Of the 4% not resolved, a fraction

gets written off, and the

remainder split between the

wholesaler and the

manufacturer, resulting in a 2.2%

loss

• Duplicate chargebacks, involving

product returned to the

wholesaler, then resold, with

chargebacks being generated

each time

• Omitted reverse

chargebacks, caused when a

product is sold, a chargeback

filed, and then the product is

returned, which should generate

a refund of the chargeback

Causes of Rebate Discrepancies

• Over payments of managed care

rebates (on an average 5.5%)

• Over payment of Medicaid

rebates (on an average 4.5%)

Causes of Return Discrepancies

• Caused by full credit being sought

for the return of only part of an

order

• 0.4% of returns are written off

due to errors

• 4% of shipments result in concealed

shortage claims

• 7% average discrepancy size

Key Revenue Leakage Points

• A key data stream that impacts all

transactions is EDI 867 or 852 data, which

usually comes from the wholesaler to the

manufacturer

• Manufacturers employ both IT systems and

staff to ―scrub‖ the data so that discrepancies

can be revealed, but the task is difficult

• Manufacturers now prefer to outsource

their data-scrubbing to specialized service

providers like CSC, IMS Health, Activus

Solutions etc

Industry Survey On Key Revenue Leakage

Points

Note:

• Survey data based on responses from 151 industry

leaders, in more than 117 pharmaceutical companies

Source: IDC Survey Results

Is revenue leakage through the chargeback process a significant problem for your company?

21.2%

18.2%

33.3%

11.1%

16.2%Unsure due to lack of evidence

Large problem

Medium Problem

Small problem

Not a problem

2006

16.0%

21.0%

42.0%

13.0%

6.0%

2009• There is an increased awareness

in the pharmaceutical industry

towards revenue leakage caused

by chargebacks

• 63% of the respondents in 2009

believed that chargebacks were

either a large or medium sized

problem compared to 37% in

2006

Is revenue leakage through pharmaceutical returns a significant problem for your company?

21.8%

10.9%

30.7%

19.8%

16.8%Unsure due to lack of evidence

Large problem

Medium Problem

Small problem

Not a problem

2006

26.0%

11.0%

32.0%

16.0%

13.0%

2009• 42% of the respondents in 2009

believed that returns were

either a large or medium sized

problem

Case Studies

4

Case Studies

Pfizer

Source: IHL Group

Total IT Spend Split (2009)

Total IT Spend = USD 1,107 Million

16%

26%

24%

34%Software

Services

Labor Overheads

Hardware

29%13%

10%

16%

5%19%

5% 1%1%

Infrastructure Storage Systems/SCMEnt. Collaboration Ent Accounting, Fin, HRBI Ent App DevSales & Mktg Commerce

In the next two years Pfizer is likely to invest in

the following technologies

• Business Intelligence

• Analytics

• Procurement/Purchasing

• Accounts Payable

• Data Transformation

• Forecasting

• Price Optimization

• B2B Ecommerce

Technologies Pfizer has already invested to plug revenue

leakages

Software Vendor

Accounting Control Model N, Oracle, SAP

ERPGrid Computing Solution, SSA ERP,

Oracle Enterprise Manager

Financials Model N, SSA BPCS

Case Studies

Top 10 Global

Pharmaceutical

Company

Challenges• Lack of visibility and control over the entire revenue life cycle

• Unable to track the performance of product in the market in real time• Order to cash process plagued with errors

Solution

ProviderModel N

Solution

Roadmap

• Model N‗ implemented Revenue Management Intelligence (RMI) analytics platform with the

transactional applications in the Revenue Management Suite. This gave the company access to in-

depth and real-time performance metrics data for various products

• Seamless integration of company’s systems with customer's SAP ERP

infrastructure to accelerate time to value and enhance the order-to-cash process

• Replaced both custom systems and a legacy contracting vendor's systems of the company

Benefits

• Model N’s solution helped the company gauge the effect of regulatory

mandates on commercial business and the bottom line• Reduced errors and cycle time in fulfilling orders

• Improved decision making though advance modeling techniques

• Improving margins and control

Source: Press Releases

Case Studies

Ranbaxy

Challenge: Ranbaxy had already implemented SAP ERP with the idea of improving business processes

within the organization. In addition the company was using EDI to streamline the entry of orders into

the SAP software and eliminate the inconsistencies between the information in the different

geographies. For the US and European geographies, the frequency of documents was almost 200+ per

day. Customers were also showing an increasing interest in submitting POs electronically instead of via

third-party systems. Hence a live integration was required between ERP and EDI.

Solution: To minimize complexity and make the most of the common system architecture Ranbaxy

implemented SAP NetWeaver PI. With the new solution in place customers and vendors were able to

see their order status, accounts and do online tracking of cargo. Orders placed online are transmitted

through EDI and automatically updated in Ranbaxy’s SAP network. Initially the system was rolled out

to overseas customers and later for domestic customers.

Benefits: About 2,500 of Ranbaxy’s partners were connected within India, apart from a similar

number in other countries. The network is serving as a powerful marketing tool and knowledge

resource for customers. The number of stockists and dealers is so large that even if 10% of them start

online transactions, the company expects to reduce physical man-hours (and errors) and increase cost

advantages. In addition, the company expects benefits such as inventory reduction

Source: Dataquest, SAP & Ranbaxy Press Releases

Appendix

5

Overview Of The Pharmaceutical Supply Chain In

India

In 2006, the market size of India‘s pharmaceutical logistics segment (distribution) was valued at around $200 million with an annual growth rate of 4%

India Organization of Chemists & Druggists (AIOCD) controls the margins of drugs in the Indian market. The maximum margins in the supply chain are

predetermined. In addition to the above mentioned margins, wholesalers and retailers are also compensated with additional trade offers

On an average, a company may work with a total of 25–35 CFAs. Unlike a CFA that can handle the stock of only one company, a stockist (distributor) can

simultaneously handle more than one company (usually, 5–15depending on the city area), and may go up to even 30–50 different manufacturers

The CFAs are paid by the company yearly, once or twice, on a basis of the percentage of total turnover of products. The stockist, in turn, after 30–45 days (a typical

credit or time limit) pays for the products directly in the name of the pharmaceutical company

Carrying &

Forwarding

Agents (CFA’s)

Stockist

Retailers

(Pharmacy/

Hospitals etc)

Pharmaceuticals

Manufacturing

Company

End Customers

(Patients)

• 1–10% on the total

turnover + other

expenses

• On an average the

margin is about 6%

• 8% on scheduled

drugs

• 10% on

nonscheduled drugs

• Drugs are sold to

end customers at

MRP + tax

• 16% on scheduled

drugs

• 20% on

nonscheduled drugsFlow of

drugs

Note:

• Supply chain illustrated is for pharmaceutical manufacturing companies in the domestic market only

• Drugs indicate formulations only and excludes bulk drugs

Margins

Source: BioPharm International