The recent Coronavirus outbreak has brought to the fore a systemic opportunity and challenge facing the pharmaceutical supply chain: the major role China has come to play in the industry both from the demand and supply sides. As companies respond to the crisis and attempt to move forward, they will need to take time to reconsider what this fact means for their supply chains and how they can improve their resiliency going forward.
Over the past several years, it has become clear that China is a strategic growth market for pharmaceutical companies. The increase in disposable income and improved access to health care in China presents tremendous opportunity for growth. The rapidly shifting age demographic in China is yet another factor. By 2050, 330 million Chinese will be over age 65. In comparison, the number of Chinese over the age of 65 as of 2019 was about 160 million. As a result, pharmaceutical companies are exporting quite a lot of specialty drugs and medical devices to China. A recent study of large pharma companies' earnings shows that the revenues in China grew by 29% as compared to a growth of 8.2% in the U.S. for a comparable period.
At the same time, China is also a major source of supply in the pharmaceutical supply chain. In recent years, China and India have emerged to be big players in the pharma space, especially in the over-the-counter and generic pharmaceutical segments. According to the U.S. Food and Drug Administration, 31% of all the U.S. registered drug chemical facilities are in India or China. Furthermore, just in the last year, China accounted for 95 percent of U.S. imports of ibuprofen, 91 percent of U.S. imports of hydrocortisone, 70 percent of U.S. imports of acetaminophen, 40 to 45 percent of U.S. imports of penicillin, and 40 percent of U.S. imports of heparin, according to Commerce Department data. In all, 80 percent of the U.S. supply of antibiotics are made in China. Even as India rises as an alternate source to China for generic and over-the-counter medications, facilities in the country still depend heavily on Chinese sources for active pharmaceutical ingredients (APIs) and key starting materials (KSMs). All in all, at this point, China has such a high degree of concentration of pharma sourcing, whether it is finished product, APIs, or KSMs, that the current outbreak puts it in the spotlight.
What's on the horizon
Given the above factors, let us examine the short-term impacts and implications of COVID-19 on the industry.
- Drug shortages will not be immediate, but they could be significant. Several leading pharmaceutical companies have put out statements assuring their investors and the general public alike that they are well covered in terms of inventories and alternate sources of supply. However, given the industry's level of dependency on China, one has to be skeptical. The pharma industry as a whole does have a sufficient inventory buffer. In fact, the median inventory is about 180 days for the industry as a whole. However, drug manufacturing has long lead times, meaning the effects of the manufacturing shutdowns in China will take time to cycle through the supply chain. If the supply disruptions of APIs or finished products made in China prolong, the effects will be severe. Missed deliveries could be punitive for pharma companies due to penalties by purchasing entities. Additionally, it will be hard for the industry to respond in an agile manner. It is not easy to switch sources of supply in the pharmaceutical industry given its highly regulated nature and the rigorous compliance requirements set by the regulatory bodies. Furthermore, in comparison to other industries, such as fast-moving consumer goods, the pharma industry has only recently started focusing on supply chain management and is not as well equipped to respond to disruptions in supply.
- The industry is continuing to see shortages of essential supplies. Demand for face masks (most of which are, coincidentally, sourced from China) and hand sanitizer has significantly increased during the pandemic, and companies have not been able to keep up. Individuals and governments alike are stocking up on these supplies, causing a significant spike in demand. The industry will also need to keep an eye on the logistics and distribution challenges related to fulfilling these demand spikes as transportation capacity has been taken away due to disruptions at the ports, crew quarantines, and labor shortages due to lockdowns. However, as the economies start to open up and lockdowns end, the situation will probably improve.
- Supply chains need to plan now for how to support the launch of a vaccine. A few companies are already vigorously working towards developing a vaccine for COVID-19. However, launching a new product is not trivial. The sense of urgency in combating the virus will open doors for fast tracking regulatory approvals. However, to capitalize on the opportunity, the companies working on the treatment should consider the capacity needs and any tradeoffs they need to make in their overall portfolio offerings, as speed to market is critical for a successful launch.
How to respond
In light of the above, what are some actions that pharma executives should focus on? In the short term, the first step should be to quickly find answers to the following questions:
- What part of my supply, and how much of it, is coming from China?
- What finished products is this supply going into?
- What alternate sources do I have to meet the demand?
Answering the above questions will help executives understand and quantify their company's risk exposure. To ensure continuity of supply, companies need to identify alternate sources and then select which suppliers to work with based on landed cost. They should also be aware, however, that as supplies start going on allocation, being the first mover to lock in on the allocation will significantly reduce risks. As pharmaceutical industry veteran Atul Tandon recommends, companies need to make sure that they are rigorous in ensuring that supplies are released per human health and business priority criteria. In exceptional situations, such as the current crisis, constant monitoring for excess consumption and diversions due to customer hoarding is key so you can take mitigating actions in a timely manner. One action, for example, is to compare current consumption with historical needs. Even after accounting for COVID-19 stockpiling, the consumption patterns from the past can help indicate where there is excess consumption. Diversion can be caused by players buying products to sell in secondary markets. Government crackdowns can help to an extent, and in exceptional situations, public-private enterprise can should collaborate with public entities to ensure better allocation of supply.
For most companies, answering the aforementioned questions is not a trivial matter. Given the complexity in the pharma industry, analytics are essential for organizations to assess risks. However, most companies' technological capabilities are anchored upon enterprise resource planning (ERP) and other planning systems that are simply not equipped to help enable resilient supply chains of the future. In the intermediate to longer term, companies will need to look to advanced algorithms powered by artificial intelligence to help them better design their supply chains in order to build resiliency and monitor for risks.
In addition, as mentioned before, source switching can be expensive in pharma, both in terms of cost and time. Companies should evaluate their supply networks for single points of failure and build redundancies into the system by identifying alternate sources. While building redundancies can come with increased costs, the downside of not having the protection when you need it can be very expensive. Designing resiliency into the supply chain should also incorporate placing inventory at the right nodes of the network. This does not mean increasing a company's working capital. It is about rightsizing the inventory in consideration of risk and resiliency.
The coronavirus impact on the pharma industry as a whole can be significant if the uncertainty persists. This is yet another reminder for the need to factor risk and resiliency into designing the supply networks.
