The Pharmaceutical Supply Chain: A Key To Corporate Profits And Public Protection

Thursday, June 1, 2006 - 00:00

In response to global concern about a pandemic outbreak of the Avian flu, demand for prescription flu-fighter Tamiflu increased as much as 10 times. With little warning of such a boom, supply could not keep up with demand, resulting in hoarding and the proliferation of counterfeit versions of the drug available on the Internet.

A Spring 2006 report by the U.S. Food and Drug Administration reported counterfeit drugs purporting to be "generic" Tamiflu but bearing no chemical resemblance to the drug have been seized at the border. The same report recounted criminal actions taken against individuals for distributing counterfeit and diluted influenza vaccines.

These are but a few examples of drug-supply concerns one country has related to the treatment of one illness. However, they illustrate the tremendous ramifications of vulnerabilities in the worldwide pharmaceutical supply chain.

And while vulnerabilities in the supply chain threaten the profit margins for any company, a fake Kate Spade purse bought on a New York City street won't physically hurt anyone. Counterfeit medications or medical devices, on the other hand, could cause health effects ranging from prolonged illness to resistant infections and even death.

The World Health Organization estimates that 10 percent of all medications distributed worldwide are counterfeit. That number rises as high as 60 percent in developing nations. Additionally, reports estimate that 5 percent of medical devices imported into the U.S. are fake as well.

Leaks in the supply chain are most likely to arise when products pass through several hands between the manufacturer and the consumer. Additionally, concerns develop when drugs, pharmaceutical supplies, or medical devices cross from one national market to another. Both situations open the drug distribution system to the introduction of counterfeit products.

By tightening controls on the supply chains for their drugs and sourced materials, pharmaceutical companies can protect their profit margins, their brands, and the public health. This article will explore the issues involved in protecting pharmaceutical supply chain integrity and steps manufacturers can take to better control vulnerabilities and assure compliance within their systems.

Weak Links In The Chain

Much of the focus on the pharmaceutical supply chain has been on wholesalers, distributors and others who are part of the network that facilitates drug distribution. Many manufacturers, through their terms of sale, require that distributors buy their products either directly from them or from their authorized distributors.

Sometimes, however, some authorized distributors do not follow those rules. Analyses have shown that hundreds of thousands of dollars' worth of unauthorized product finds its way into the mainstream distribution. This may be legitimate material produced by the manufacturer which has become available at a below-market price.

A secondary unauthorized distributor or a small or regional player may then acquire that product either within or outside of the legitimate supply chain, and sell it to another distributor at a profit but still below market price. Clearly, while the original manufacturer has realized a sale, arbitrage such as this cuts into the manufacturer's profits.

Manufacturers are considering clamping down on this activity by further tightening their terms of sale. For example, they are evaluating direct sales, skipping the authorized dealer requirements and selling all of their products themselves directly to end customers. Additionally, they could work with dealers to assure retailers that they are only receiving genuine products. Many pharmacies are interested in this option to limit their own liability for potentially selling counterfeit drugs.

Manufacturers also could step up oversight and enforcement of their own policies. Terms of sale are increasingly including clauses that the distributors will provide transactional data to the manufacturers. That allows for much-needed analysis of who is selling what to whom to ensure that the amount of drugs the manufacturer made and sold matches the amount of drugs sold to retailers and, ultimately, consumers.

Steps to crack down on distributors' options, though, can meet with resistance from those who earn a portion of their annual revenue buying and distributing drugs from secondary channels. New fee-for-service business models are emerging. For example, in response to a manufacturer's request for transactional data, wholesalers and distributors have responded by offering to sell their (proprietary) transactional data back to the manufacturer to facilitate an audit of the system while recouping their lost revenue. This can become a win for the consumer too; it provides increased assurances that only legitimate products are reaching them.

Supply chain control and compliance concerns take on a whole other dimension when it comes to the European Union. EU authorities have a strong focus on enabling competition. Commonly accepted practices in the U.S. such as wholesaler audits and transactional analyses are not readily available if they are seen as restricting the free flow of goods within the common market. For that reason, parallel trade - the use of secondary sources - between and among markets is not only legal, but encouraged in the EU. To make matters just a bit more complicated, individual country governments generally set prices for prescription drugs sold locally, which sets a perfect stage for arbitrage.

Distributors in a low-price market such as Greece can purchase considerably more product than that market can bear and then sell the excess into a higher-priced market such as the UK. The price on the resold drugs and supplies bought originally in Greece is still lower than the market price in the UK, so the UK distributors and the Greek distributors both come out ahead. The only one whose margin suffers is the manufacturer.

Efforts to limit sales into the lower priced markets are considered anti-competitive. Some have tried to work within the regulations by managing the inventory available in those markets in a way that they hope will not be viewed as limiting product flow, but such practices continue to be legally challenged.

Another approach that some companies advocate is the use of a dual-price system for pharmaceuticals in the European Union. Such pricing allows distributors to sell drugs at a low price, so long as they can demonstrate they sold it within a specific market. They must sell it at another, higher, price if they cannot so demonstrate. The system is designed to make parallel trade unattractive to the importers, which may be a promising way to encourage distributors to buy only what they need in their markets. This would protect the manufacturer's profit margin, but it would also help to solidify the supply chain and seal any potential leaks.

In developing countries, the supply chain is even less defined. Some manufacturers have acknowledged that they do not know where their product goes when they send it into parts of Asia or Africa, for instance, given the multitude of suppliers in those markets. This sets the stage for all kinds of problems, including the sale of counterfeit drugs in the developing countries and the reselling of both legitimate and counterfeit drugs into developed nations.

This is a very serious concern for any manufacturer interested in protecting their brands as well as their bottom lines and the public health. It is imperative for those selling into emerging markets to map their product flows to both constrain and manage it. They also must perform thorough due diligence to select distributors they can rely upon, put in place control systems to monitor their distribution networks, and follow up with compliance reviews on the grounds that are appropriate for the legal system under which they must operate.

Gateway For Counterfeits

The problems of leaks in the supply chain and counterfeit drugs are inextricably intertwined. A mere 5 percent of respondents to an MORI survey on counterfeit goods said they would be willing to knowingly purchase counterfeit pharmaceutical products. This is compared to 76 percent of respondents who said they would knowingly purchase counterfeit clothing or footwear.

Those responses prove that unless counterfeit drugs find their way into the legitimate distribution chains, there would be little to no market for them. Therefore, by sealing the leaks in the pharmaceutical supply chain, manufacturers could go a long way toward conquering the counterfeit problem and protecting their own brands as well as the public health.

And counterfeiting presents a considerable problem to manufacturers. When consumers use a counterfeit pharmaceutical product or a medical device, their trust in that brand will be affected. On a grander scale, recalls cause considerable bad publicity for the company, and consumers may switch to a similar product produced by another company they think is safer.

So the pharmaceutical supply chain is critical in protecting a company's brand, but they also have some well-publicized vulnerabilities. Anyone who watched the news during the 2000 and 2004 presidential elections knows that cross-border sales are not isolated to Europe. U.S. citizens, particularly those who live near either the Canadian or Mexican borders have quite publicly ventured across those lines to take advantage of price differentials. The threat of counterfeits through these channels has risen to such a level that the U.S. recently added Canada to its Special 301 Watch List, with note made of the amount of trade that occurs in counterfeit goods within and across its boundaries.

Pharmaceutical companies also believe that Internet sales of drugs represent a tremendous risk to the company and its brands. Illicit online providers are trading on the company's brands. If the public ceases to trust the manufacturer, it will find and buy a competitor's product. As a result, companies develop brand protection programs to monitor the use of their trademarks and domain names on the Internet in efforts to protect their customers.

Today manufacturers also should focus on their sources. Who are they? Are they diverting materials? Are they supplying legitimate materials to the manufacturer? Any part of the process that is outsourced creates another risk for counterfeiting.

Managing Supply Chain Risk

Tight controls and their vigilant compliance truly are the keys when it comes to mitigating risk in the pharmaceutical supply chain. Coordinated efforts to monitor these controls must be built into formal compliance programs or brand protection offices. With the right processes and policies in place to oversee transactions and other distribution terms, manufacturers can better understand what happens to their products and control them once they leave their factories.

This goes beyond a profit margin issue. Making sure the correct medications get to the people who need them is an obvious public-health issue. And if a major problem develops that endangers public health, that would clearly detrimentally affect a manufacturer's brand and possibly its other products as well.

Companies that have undertaken significant supply-chain control and compliance programs have indeed spent time and money implementing them. One company, though, claims to have realized a 100-1 ratio when comparing their quantified risk to the cost of their program. While returns may not be quite that high for every company, compliance is worth the investment.

Pharmaceutical supply chains can be murky matters, but manufacturers do not have to operate in the dark.

Jerry Wald is a leader in the Brand Protection Group with Ernst & Young's Fraud Investigation &Dispute Services practice. He is based in Phoenix, Arizona.

Please email the author at jerry.wald@ey.com with questions about this article.