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Strategies to succeed in the “new normal”

April, 2013

CONFIDENTIAL AND PROPRIETARYAny use of this material without specific permission of McKinsey & Company is strictly prohibited

Ulf Schrader

Trend in pharma and implications on operations

McKinsey & Company | 1

Contents

SOURCE: McKinsey

The new normal

Looking into the mirror

Strategies to succeed


1,600

600

1,400

1,200

1,000

800

+131%

09

400

200

00504 080706030201009998979695949392919089

Pharma industry revenue pool has more than doubled over the past 20 years

SOURCE: S&P Capital IQ Unit; McKinsey

INFLATION-ADJUSTED

Pharma industry revenues, 1989-2009

$ bn


Over the same time period, pharma industry profit pool has more than trebled

SOURCE: S&P Capital IQ Unit; McKinsey

INFLATION-ADJUSTED

220

200

180

160

140

120

100

80

60

40

20

0

1,600

1,400

1,200

1,000

800

600

400

200

0

+278%

+131%

090807060504030201009998979695949392919089

Pharma industry revenues, 1989-2009

$ bn


Recently, growth was mainly driven by emerging markets, while Europe declined

SOURCE: Business Monitor International (5. Apr. 2013)

RoW

BRICTM2

Japan

EU 1

US

2009

~ 1 bn

Pharma sales development at constant exchange rate (2011)USD billion

CAGR (2009-12)Percent

3

-1

3

13

9

4

1 EU countries + Switzerland, Norway, Croatia2 Brazil, Russia, India, China, Turkey, Mexico

INCLUDING INFLATION


6

10

16

23

12

17

8

11

16

19

25

2009 sales at risk because of U.S. patent expiries, 2010-17, $ bn

Pharma facing unprecedented period of loss of exclusivity

Share of 2009 pharma sales at risk because of U.S. patent expiries, 2010-17, %

40

52

79

72

43

42

34

30

39

45

54

Ø 48

SOURCE: Evaluate 2010


Sales of selected Gx companies1

Indexed (2002 = 100), percent

Generic companies have doubled in sales every 4 years

0

50

100

150

200

250

300

350

400

X 2

X 2

2010090807060504032002

1 Sum of the annual sales of Teva, Mylan, Hospira, Watson, Perrian, STADA, Ranbaxy, Dr. Reddy’s, Cipla, KRKA DD, Gedeon, Sun, Lupin, Cadila, Aurobindo, Wockhardt, Matrix, Hisun, Glenmark, Torrent, Daewong, Piramal, Haw Par

SOURCE: Annual reports; McKinsey


Omeprazole Paroxetine Alendronic acid Amlodipine

70 mg tab.20 mg tab./caps.

Fiscal pressures continue and lead to radical prices cuts

0.36

-93%

JuneMay

4.99

Q2

0.270.05

-86%

JuneMay

0.36

Q2

0.04

5 mg tab.20 mg tab.

0.07

-81%

JuneMay

0.37

Q2

0.11

Q2

0.030.03

-85%

JuneMay

0.19

SOURCE: McKinsey

Impact of healthcare reform on selected products in NetherlandsPrices in $ per standard unit

Netherlands India


Quality issues and regulator activity have intensified

Issues Actions Speed of response

U.S. drug recalls U.S. GMP warning letters % of warning letters issued within 4 months of inspection

844

254

+27% pa

20102005

49

18

20102005

+22% pa +14% pa

2010

27%

2005

14%

SOURCE: FDA

McKinsey & Company | 9SOURCE: Company websites; press

Local location required by regulation

Local location advantageous but not strictly required

Percent

Share of top pharmaco FDF plants

~30

Share of global pharma sales

13

Protectionist policies demand high number of „market access“ plants


Companies are facing increasingly unpredictable and rapid changes

Growing scale, scope, and pace of uncertainty

Value stream

Macro/ regulatory

Non-economic

▪ Customer demand

▪ Input cost volatility

▪ Social-network influences

▪ Value chain restructuring

▪ Government policies

▪ Exchange rates

▪ Emerging market growth

▪ Regulatory approvals

▪ Pandemics

▪ Political unrest

▪ Natural disasters

▪ Activism

Ab

ilit

y t

o c

on

tro

l/in

flu

en

ce

SOURCE: McKinsey


Increase in counterfeit drugs has been substantial

SOURCE: Press searches; Pharmaceutical Security Institute; WHO

Number of drug-counterfeiting incidents in the U.S., 2002-2009

2,0021,8341,759

1,412

1,123964

484

190

+40% pa

20092008200720062005200420032002

30% of all drugs in Africa are believed to be counterfeit


Contents

SOURCE: McKinsey

The new normal




Pharma starts from a very high base

SOURCE: Company Web sites; McKinsey

Headquarters of leading innovative Pharmacos

Headquarter of Teva


Pharma industry cost curve shows a very immature industry

SOURCE: POBOS

0

50

100

150

200

250

300

350

400

450

500

550

600

Sites (solids)

Overall Productivity, '000 PUs per FTE

+50%

median

top quartile


>40 companies

>400 plants

>8000 production lines

100 new plants in 2012


Changeover time on FETTE 2090 Staffing level on IMA C90 – A91

Hours Number of operators

Major

8.0

4.0

16.0

Minor

1.0

0.6

2.0

Line staffing

3.5

3.0

5.5

Lower Q

Medium

Top Q

SOURCE: POBOS

High spread also on individual practices - examples


Large spread within pharmacos indicates lack of a “production system”

Overall productivity, ‘000 Productions Units/FTE

0

50

100

150

200

250

300

350

400

450

500

550

600

650

326.0

5

219.0

7 8

213.0

150.0

4

203.0

62

191.0

3

252.0

1

185.9

Company average

Top performing

Worst in group

Companies

SOURCE: POBOS


Maintenance productivity

Reliability

Only 10% of plants achieve high reliability at low maintenance cost SOLIDS

STRONGPOOR

LOW

HIGH

SOURCE: POBOS

40%

10%


Performance of pharma quality systems is on average at 3 sigma

SOURCE: POBOS

13

02

122

3

12

911

16

23

18

8587 83 7381 757779899193959799

First-time right rate (%)

Avg. 93.8%3 σσσσ

99.4%4 σ

% of pharmaceutical plants


+11%(2008-2010)

84

16

63

37

43

57

Produced batches Recalls

Justified complaints

-1%(2008-2010)

CaptiveExternalOverview of complaints for third party vs. own production

SOURCE: McKinsey; client example

CLIENT EXAMPLEExternal supply is often undermanaged


Contents

SOURCE: McKinsey

The new normal




SOLIDS

SOURCE: POBOS

1 Line staffing for compression and packaging

OEE

Line staffing1Median quartile productivity

Bottom quartile productivity

Top quartile productivity

Fixing the basics still remains a top priority


US/Western Europe

OEE, packaging (based on validated speed), percent

OEE still shows huge potential

SOURCE: POBOS, Rx plants, solids

41

50

65

+59%

AverageTop 25%Top 10%


11

4

Transfor-mationalapproach

Traditional cost reduction

x3

SOURCE: POBOS

Average year-on-year unit cost reduction, % before inflation

Transformations outpace traditional cost reductions by factor 3


Justified complaints (ppm)

6.66

5.04

1.67

-75%

Bottom quartile

Middle quartiles

Top quartile

Average USD cent/production unitN = ~200 solids sites

SOURCE: POBOS

Excellence in operations correlates with high quality

McKinsey & Company | 26SOURCE: POBOS

13.4

8.0

3.0

-78%

Top quartile(avg. = 0.6)

Bottom quartile(avg. = 2.0)

Middle quartiles

(avg. = 1.1)

Waiting time between formulation and packaging

Working days

Minor changeover timeHours

Operational excellence also increases the agility


Pharma needs to move from “projects” to a “production system”

Just-in-time

The right product/service with the right quantity at the right time and at the right cost

▪ Stick to the client need

▪ Adapt resources to the demand

▪ Reduce lead time

Quality

Transfer only the right part or the right service to the next step

▪ Do it right the first time

▪ Stop at the first defect

▪ Answer rapidly to problems

Kaizen

Continuous improvement

▪ Think process

▪ Think standards

▪ Think improvements

▪ Measure to improve

▪ Apply San Gen Shugi

▪ Work in team

▪ Understand client needs

▪ Understand the added value

▪ Follow working standards

▪ Train through on the Job Training

Foundation: Good mindset and good behaviour

Production systems delivered impact across industries

production system

SOURCE: Press clippings, web sites


Site locations

Site footprint is still skewed towards high cost countries

Note: Rx incl. Abbott/Solvay, Amgen, AZ, Bayer, BI, BMS, Lilly, Genentech, GSK, J&J, Merck, Novartis, Novo Nordisk, Pfizer/Wyeth, Roche, Sanofi; Gx incl. Actavis, Hospira, Ranbaxy, Sandoz, STADA, Sun, Teva, Zydus Cadila; only pharma and consumer sites, excl. all dedicated animal health or medical products sites

SOURCE: Espicom; press releases; McKinsey expert interviews

56

28

44

72

Average Gx

100

Low cost countries

High cost countries

Average Rx

100

Percentage of all pharma and OTC sites


Offshoring still remains an opportunity, especially for emerging markets

Top quartileAverage

17

46

-62%

LCCNon-LCC

61

96

-36%

LCCNon-LCC

SOURCE: POBOS

Unit cost in USD cents/Production Unit

LCC: Low cost countries


World's cheapest production car brings mobility to the masses

Lowest-priced microwave adaptive to Chinese cooking style

30

Design-to-value and platforming is a big lever in other industries to win in emerging markets

SOURCE: Interviews and press search

Launched to support student community in India

Eliminated display, added languages, market rates for goods, e.g., vegetables

20 instead of 200 parts. Uses PC chips and fans

Wind-turbine manufacturer eliminates product complexity

First incubator for rural babies - no electricity or training required

Ultra portable and a fraction of the cost of traditional machines

“Sakshat” Laptop ($30)Spice mobile phone ($12)

ChotuKool fridge ($69)

Embrace baby incubator ($25)

Tata Nano ($2,000)

Galanz microwave ($50)

Sinovel wind turbines (price 20% < competition)

GE MAC 400 ECG Machine($1,000)


Design-to-value can also yield big value in pharma

15,000

-85%

GE low-cost ultrasound unit

Standard ultrasound unit

100,000

0,03

-99.99%

Bharat Biotech price

Average wholesale price in U.S.

40,00

SOURCE: McKinsey

Ultrasound unit$/unit

Hepatitis B vaccine$/dose


Atomization of the value chain will drive performance also in pharma

SOURCE: McKinsey

Front end design

Core design

Back end design

Manufacturing equipment

Wafer fabrication

Assembly

From 1970s view …“do it all”

… to 2000s view:“atomized”

Front-end design

Core design

Back end design

Manufacturing equipment

Wafer fabrication

Assembly

Sales and marketing

In-house (ARM provides key components)

In-house

Engineering design/

automation

Engineering design/

automation

Example from High-Tech


Building agility into the system will be key to succeed in a volatile environment

SOURCE: McKinsey

Manufacturing agility

Workforce agility

Supply chain agility

Suppliermanagement

agility

Product development

agility

Capitaland risk mgmt.


When lightning struck, Nokia was able to leverage its supply chain setup to respond efficiently and mitigate risk

SOURCE: A. J. Schmitt, Using Stochastic Supply Inventory Models to Strategically Mitigate Supply Chain Disruption Risk, Logistics Spectrum, 2008; EIU "Managing supply-chain risk for reward"

In 2000, lightning struck a Philips microchip plant in New Mexico, causing a fire that contaminated millions of mobile-phone chips

▪ Reported long-term losses of $2.3bn

▪ Ultimately withdrew from the cell-phone market

▪ Profits rose by 42%

▪ Increased their market share from 27% to 30% in the first 6 months after the fire

Lightning struck Impact on Ericsson and Nokia

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