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Outsourcing Risks Worry the Wary

Senior finance executives in the pharmaceutical industry say their enthusiasm for outsourcing is tempered by regulatory, data security, and process integrity risks.
Alison Rea, CFO Research Services
October 14, 2004

Biotech and pharma CFOs worry that by loosening their grip on their entire enterprise and relying on third parties, they might risk losing their competitive edge. Desired cost savings and productivity gains may fail to materialize; it may take too much management time and attention to move operations to an outsourcer; and quality and performance could suffer. "Pharmaceutical companies are notoriously conservative on everything they do. They do not like to give up control of anything," says Andrew Bonfield, chief financial officer at Bristol-Myers Squibb.

Even though many big firms enter alliances for drug discovery, development, and marketing, CFOs say they do not equate these practices with outsourcing. They say alliances generally do not entail assigning an internal process to another party. Instead a product is licensed and managed or firms work together more closely, as in joint ventures.

In interviews, CFOs cite a number of risks that make them pause when considering outsourcing. These include:

• Very low tolerance for error
• Dread of delay
• Meeting the demands of regulatory compliance
• Adjusting to the Sarbanes-Oxley Act
• Security of proprietary knowledge
• The management challenge

Very low tolerance for error. In the drug and biotech industries, mistakes can carry big price tags. Regulators could delay approval, or a drug's true effect could be masked, compromising results. In the worst case, patients could be harmed and massive liabilities incurred. "We have a very low threshold for error. We have to do everything right, and we are in a hurry. We feel like people are waiting for us to get important new products approved for the treatment of life-threatening, life-altering diseases. That is the really key driver of our business and why we are in one location in South San Francisco, and why we are not interested in outsourcing," says Joe McCracken, senior vice president of business and commercial development at Genentech. "The cost savings do not justify the risks."

Clearly the integrity of data has a bigger impact in pharma and biotech than in many other industries, and as a result, companies outsource their IT functions with great care. Russ Bantham of the Pharmaceutical Research and Manufacturers of America cites industry fears about maintaining data integrity, saying, "If you have a glitch and the data gets entered wrong, there's a problem. Can you imagine sending these things offshore, and you can't quite understand what the IT guys are saying or they have no understanding of the importance of the data? Misreading, losing, or mis-entering one piece of data could result in a multibillion-dollar lawsuit."

Dread of delay. Any delay — whether due to regulatory holdups, a flawed process, or an inefficacious drug — is costly in the pharmaceutical industry. "Once you present data to a regulatory body like the FDA, if they find that it is messed up, that sets back your whole research," says Bantham. According to another finance executive, who asked not to be named, "The loss is pretty significant pretty quickly if the product is out of the market for long."

Meeting the demands of regulatory compliance. Drug companies must comply with rigorous and expensive regulations worldwide. Using third parties could make compliance more cumbersome, costly, and risky. Not only is every step of the manufacturing process subject to regulatory specifications, but recent privacy laws have been passed in several countries that might impede data sharing.

Given that some changes are quite recent, companies are scrambling to comply. For example, the FDA is currently implementing an electronic signature regulation under which all electronic records must be documented in accordance with FDA guidelines. Christopher-Paul Milne, assistant director of the Tufts Center for the Study of Drug Development, says that since the new rule probably extends to all data in New Drug Applications and to the personal records of investigators and patients, it heightens concerns about outsourcing HR and IT operations.

Adjusting to the Sarbanes-Oxley Act. Some CFOs pause before outsourcing finance and accounting functions until they understand the ramifications of the Sarbanes-Oxley Act, which holds senior management accountable for the accuracy of financial statements. To outsource finance activities now requires great confidence in the vendor's controls.

David McGirr, chief financial officer at Cubist Pharmaceuticals, reflects this wait-and-see attitude. "Sarbanes-Oxley has just tightened the focus on financial control and processes. While we're all learning to live with Sarbanes-Oxley — and the rules are still being written — it's going to be very hard to outsource some finance functions," he says. "When it all settles down, and people become comfortable, maybe that will change. But for now, speaking very personally, I would not want to be outsourcing much from the finance function because it's too delicate."

By contrast, Jeffrey Black, chief financial officer at Endo Pharmaceuticals, says that outsourcing a portion of internal audit has made it easier to comply with Sarbanes-Oxley by giving the company access to experts. "We were able to address some of the concerns of Sarbanes-Oxley and draw on expertise from outside groups with experience in implementation and monitoring the rules," he says.

Security of proprietary knowledge. No firm wants to risk losing a key formula or manufacturing edge because it outsourced. This is especially true in offshore destinations where legal systems may not offer the same intellectual property protection. "Clearly if you go offshore, the ability to protect your proprietary information — such as your patents — is subject to much higher risk," says Maurice Greaver, president of Greaver & Associates. "In low-cost countries, if you're not careful, you could go to the market and they'll be selling medicines that are identical to yours."

The management challenge. The potential difficulty of managing a collaborative partnership throughout its life also dampens enthusiasm for outsourcing, especially with the complications of distance, language, and time differences that accompany offshoring. Christopher-Paul Milne, assistant director of the Tufts Center for the Study of Drug Development, believes that outsourcing may be more trouble than it is worth because as many as 20 or 30 people per project often must be retained in-house to supervise the transition and manage the relationship.

Despite these risks, forward-looking companies can still capture much of the value of outsourcing by contracting with third parties for services that are highly routine and don't have a direct impact on security, regulatory compliance, or product delivery.

This article is excerpted and adapted from Outsourcing among Pharmaceutical and Biotech Firms, a report that summarizes the findings of interviews with executives and professors at 13 companies and institutions. CFO Research Services and A.T. Kearney, a global management consulting firm, developed the hypotheses for the research jointly. A.T. Kearney funded the research and the publication of the findings; CFO Research Services produced the final report. You may download a copy of the full report by filling out a brief form.