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...
Alison ReaOctober 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:

Drive Business Strategy and Growth

Drive Business Strategy and Growth

Learn how NetSuite Financial Management allows you to quickly and easily model what-if scenarios and generate reports.

• 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.