Influences of Trends on the Pharmaceutical
Distribution Network Design:
A Case Study
Master thesis, MSc Supply Chain Management
University of Groningen, Faculty of Economics and Business March 19, 2016
PHILIP DITCHFIELD Student number 1878506 e-mail ph.ditchfield@student.rug.nl
Supervisor Prof. dr. D.P. van Donk
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Table of contents
Abstract ... 4
1. Introduction ... 5
2. Theoretical background ... 7
2.1 Changing forces in the distribution network ... 8
2.1.1 Regulatory forces ... 8
2.1.2 Channel forces ... 9
2.1.3 Compensation forces ... 10
2.1.4 Product forces ... 10
2.2 Distribution network design ... 11
2.2.1 Distribution network design options ... 12
2.3 Pharmaceutical distribution network ... 16
2.4 Pharmaceutical goods ... 17
3. Research methodology ... 18
3.1 Method and case ... 18
3.1.1 Data collection ... 19
3.2 Data analysis and interview protocol ... 20
3 5.1 Regulatory forces ... 28 5.2 Channel forces ... 29 5.3 Compensation forces ... 29 5.4 Product forces ... 30 5.5 Summary of discussion ... 30 6. Conclusion ... 31 6.1 Managerial implications ... 32
6.2 Limitations and future research ... 33
7. References ... 34
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Abstract
Purpose – This research aims at determining which trends that were identified by Rossetti et al.,
(2011) influence the pharmaceutical distribution network in Europe and more importantly, it tries to assess how these trends influence this distribution network design. This research contributes to theory by finding how pharmaceutical distribution networks should be designed.
Methodology – A single in-depth case study was used and several semi-structured interviews are
conducted with participants at different levels in the distribution network.
Findings – This paper discovered that all four forces (regulatory, channel, compensation and
product) were influential. For each force, the analysis pointed out whether the distribution of generic medicines, or the distribution of specialty medicines was influenced. Eventually, channel and product forces only related to the distribution network design of specialty medicines where a direct to customer model will become more common. Compensation and regulatory forces influenced both the distribution network design for generic and specialty medicines. Generic medicines are likely to be distributed by consolidating shipments and storing at the wholesaler.
Limitations/implications – Methodologically, a single case study limited the generalizability of
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1. Introduction
Nowadays manufacturing companies face challenges to produce, distribute, and design products for the global market and to simultaneously manage the global network of operations as efficient as possible (Olhager, Pashaei & Sternberg, 2015). This is even more apparent in the pharmaceutical industry where the supply chain is characterized by many products and where intermediates are produced in multi-site, multi-stage production systems (Meiler et al., 2015). In addition, problems related to developments of IT-systems, the emergence of generic medicines, and the constantly revising regulatory environment are changing the competitive landscape for manufacturers, wholesalers and retailers in the pharmaceutical industry (Vitale, 2014). Managers have difficulties tackling these developments, considering that a number of pharmaceutical companies is not able to meet market demands in a consistent manner (Mousazadeh, Torabi & Zahiri, 2015). To improve upon this non-optimal situation, it is necessary to understand how changes in these developments influence the distribution of pharmaceutical products. This understanding may inspire the industry, and research aimed at these dependencies, to improve the distribution network design (DND).
6 identification of these forces and their impact can pro-actively help managers and researchers to design the distribution network.
When designing the distribution network, two questions can be asked regarding the decisions that have to be made (Chopra & Meindl, 2001): (i) are the medicines going to be shipped directly to the customer, or are the medicines going to be picked up at some pre-ordained site? (ii) Is an intermediary used for transporting the medicines? These questions relate to designing the distribution network and three steps can be identified in the process of the design (Mangiaracina, Song & Perego, 2015). The first step, is to develop different distribution network options and assess them preliminary. The second and third step relate to the use of quantitative models, but these steps are beyond the scope of this research. Thus focusing on the first step, Chopra (2003) found several DND options that could be evaluated through cost and service factors. By linking the abovementioned forces with these two factor groups, this research tried to explore how forces would influence the DND in the pharmaceutical industry. The question this paper sought to answer is:
Q1. How will major forces impact the pharmaceutical distribution network design?
7 The rest of the paper will be organized as follows. First of all, in the following chapter the theoretical background will be presented. In Chapter 3, subsequently, the methodology will be discussed. Section 4 will present the findings from the empirical data that was gathered during the case study. To end with, Chapters 5 and 6 will contain the discussion and conclusion.
2. Theoretical background
Logistics managers in the pharmaceutical industry are foremost concerned with the flow of goods from the supply points (manufacturing facilities) to the demand points (e.g. wholesaler, retailers), which is referred to as the ‘distribution network’. In order to design the distribution network to achieve the optimal service level and minimal costs, both cost factors (i.e. facility, inventory and transportation) and service factors (i.e. response time, product variety and customer experience) should be considered (Chopra, 2003). Also, the design of the distribution network is sensitive to the changing external environment. This is in particular true for the pharmaceutical industry where regulatory, compensation, channel and product forces vastly impact the DND (Rossetti et al., 2011). The abovementioned interrelationships are depicted in Figure 1.
Figure 1. Research scope
8 2.1 Changing forces in the distribution network
Pharmaceutical companies are constantly looking for opportunities on how and where to distribute their medicines because the supply chain is subject to several forces that continuously change the distribution landscape. An analysis of these forces can guide future decision makers on how to design the pharmaceutical distribution network. Rossetti et al. (2011) identified four categories of forces that affect the way medicines are distributed throughout the supply chain in the United States. Their findings were used as a basis for the following section. The four categories are:
1. Regulatory forces: increasing pressure from regulatory institutions may change the way medicines are distributed
2. Channel forces: the use of alternative channels like direct channels like direct to patient (DTP) and direct to hospital (DTH) models, and internet pharmacy
3. Compensation forces: the use of inventory management agreements and fee-for-service models.
4. Product forces: product diversity is increasing and new products require special handling
2.1.1 Regulatory forces
Medicines are highly regulated goods and restricted by public authorities because of their impact on the population’s health (Jaberidoost et al., 2015). Jaberidoost et al., (2015) researched “regulation issues” and their risk impact on the pharmaceutical supply chain. In order to prevent inefficiencies in the distribution, it is essential to identify regulatory obstacles and to create a best practice for adaptability and configuration in the pharmaceutical industry (Naraharisetti & Karimi, 2010; Jaberidoost, Abdollahiasl & Farshchi, 2012). Ironically, few models have taken regulation into consideration in distribution network design (Mangiaracina et al., 2015). One issue is particularly important in the pharmaceutical distribution network: the Good Distribution Practices (GDP).
9 “[…] that part of quality assurance which ensures that the quality of medicinal products is maintained throughout all stages of the supply chain from the site of manufacturer to the pharmacy or person authorised or entitled to supply medicinal products to the public.” (European Commission, 2013: 13)
The GDP may be influential to pharmaceutical companies because these guidelines guarantee a certain level of quality of distribution practices that has to be obtained for all involved parties. Because of the variety of healthcare systems across Europe, the changes in for example GDP are difficult to anticipate which creates uncertainties. In order to tackle these uncertainties, the design of the distribution network should be flexible in terms of distribution. If the target of the distribution network is responsiveness, the distribution network should be decentralised in different centres, accompanied with dedicated investments and precise management systems (Costantino, Gravio & Shaban, 2014). Overall, the inventory will increase with decentralization and logically costs rise. Thus, a balance has to be found between the inventory and flexibility required (Waller, Dabholkar & Gentry, 2000).
2.1.2 Channel forces
Contrary to regulatory forces, channel forces are internal developments that change the structure and relationships within the distribution network for specialty medicines. In the traditional distribution network, most of the specialty medicines are sold through wholesalers. Wholesalers act as intermediary players who simplify payments and, information and product flows by helping individual producers’ goods and services meet the market demand (Stern & El-Ansary, 1992). In the pharmaceutical distribution network, wholesalers play and have played an important role in the distribution of medicines. In Europe, 74% of the demand flows through wholesalers of which the largest part goes to hospitals (Walter, Dragosits & Said, 2012). However, developments like direct-to-patient (DTP), mail orders and web site pharmacies have altered the traditional market channels (George, Whitehouse & Duquenoy, 2013).
10 leave out the wholesaler to ship a part of their medicines directly to customers in order to save money.
Besides the DTP and DTH model, some researchers found that internet pharmacies have become booming as they allow consumers to buy medicines in a conventional way, with increased choice, increased information availability, more anonymity and sometimes even lower costs (George, Whitehouse & Duquenoy, 2013). Citizens of some EU countries are allowed to buy small quantities of medicines from both their own country and overseas which increases the different channel flows of medicines in Europe.
2.1.3 Compensation forces
Compensation forces are the possible compensation models used for services delivered by the wholesaler to the manufacturer (e.g. inventory management). Traditionally, manufacturers pay a percentage of the costs of goods sold to the wholesaler. This was beneficial for the manufacturer when it would ship generic medicines, and unfavourable if they would ship specialty medicines. The most recent development, however, is the fee-for-service (FFS) model which is an activity-based pricing model (Rossetti et al., 2011). Besides the justification of prices, this model increases trust and openness in the relationship between wholesaler and manufacturer (Stevenson & Cabell, 2002).
Another issue with respect to compensation between manufacturer and wholesaler is the inventory risks born by wholesalers. Usually the wholesaler holds the inventory for the manufacturer and therefore they also bear the risks associated with holding inventory (Xianghua, Sethi & Houmin, 2005). According to Rossetti et al., (2011) most of the manufacturers they researched, were aware of the infrastructure needed to keep up to sustain the service level, but they were less aware of the risks related to owing the inventory needed for these service levels. The result was that most manufacturers did not agree on the FFS model because they considered the prices too high for the services of the wholesaler.
2.1.4 Product forces
11 Whereas generic and over-the-counter (OTC) medicines are sometimes sourced similarly to other commodities by retailers, human plasma-based and biological drugs require a cold chain distribution with specific temperature and humidity environment (Rossetti et al., 2011). Manufacturers should therefore evaluate their own product portfolio and match this to third-party logistics providers who can actually provide this cold-chain service. In addition, some of these products are personalized (i.e. ingredients are composed to an individuals’ genes) and also require a customized delivery. Product customisation changes the manufacturing process and logically, the distribution practices have to adapt. Primary manufacturing facilities were used to produce in batches of 1 to 4 million tablets, but customisation of products requires a redesign of the supply chain (Shah, 2004).
2.2 Distribution network design
The design of the distribution network requires a structured approach due to the high amount of alternative decisions and the variety of distribution options (Mangiaracina et al., 2015). This approach is split into three steps (Rushton & Saw, 1992): 1) develop configuration alternatives and assess them preliminary, 2) assess the alternatives quantitatively and 3) design and fine-tune the final choice. The first step, developing configuration alternatives, is synonymous to “developing distribution options” (Chopra, 2003) and entails the qualitative part of designing the distribution network.
12 abovementioned terms and the following definition will be used: DND is concerned with shaping the structure of the distribution network by determining the echelons (e.g. plants, wholesalers) that should be included and for – each echelon – the type, size, location and number of facilities and the links among them.
The distribution network design can be decomposed into three different sub-networks according to Jang et al., (2002): inbound network, distribution network and outbound network. In this paper, conversely, DND refers to activities from both the distribution network as well as the outbound network. The distribution network includes both the manufacturing facilities where final products are produced, and the distribution facilities. The outbound network consists of distributors close to the customers and the customers, see Figure 2 (Jang et al., 2002). Hence this paper will look at distribution options for the flow of goods from plants to customers.
Figure 2. Distribution network and outbound network (adopted from Jang et al., 2002) 2.2.1 Distribution network design options
13 experience are considered ‘service factors’ (Chopra, 2003). These six most relevant factors, divided in two groups, are:
Cost factors Facility Inventory Transportation Service factors Response time Product variety Customer experience
Increasing the number of facilities logically increases the inventory and the ensuing inventory costs. On the other hand, if for inbound transportation the economies of scale are sustained, an increase of the number of facilities decreases the transportation costs (Chopra, 2003). These costs will decrease up to the point that economies of scale in inbound transportation are lost. A company may choose to enhance responsiveness if the revenues from increasing responsiveness outdo the increase of costs of increasing the number of facilities. Furthermore, including inventory and transportation costs in distribution network problems is important because the exclusion of inventory and shipment costs lead to a sub-optimal result when determining the location of the facilities (Shen, 2007).
Furthermore, three service factors are evaluated. Response time is sometimes used as cycle time (Mangiaracina et al., 2015) and refers to the time between the placement of an order by the customer and the actual delivery of the product. Product variety has to do with the number of different configurations or products that a customer can desire from a distribution network. Customer experience is the ease for customers to place an order and to receive it.
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Manufacturer storage with direct shipping entails shipments from the manufacturer to the end
customer without the intervention of any retailer. This option is also referred to as ‘drop shipping’. The main advantage of this configuration is that inventories can be centralized at the manufacturer. Subsequently, with a lower level of inventory, manufacturers can provide a relative high level of product availability. This system is in particular preferred for products with high value, low demand and unpredictable demand (e.g. personalised medicines). However, transportation costs are relatively high because it is not unusual for such shipments to be less-than-truckload (LTL) which means that an order is not enough to fill a complete trailer. Information, flows from the manufacturer via the retailer to the customer (see Figure 3).
Figure 3. Manufacturer storage with direct shipping
Manufacturer storage with direct shipping and in-transit merge means that unlike the direct
shipments, these packages are first consolidated so that the customer receives only package from the manufacturer (see Figure 4). Aggregation of inventory and product customization is the biggest advantages of this option and therefore this option is beneficial for products of high value and unpredictable demands. Product variety and response time is similar to drop shipping.
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Distributor storage with carrier delivery: inventory is not kept at the manufacturing plant but
instead it stays at the distributor’s or retailer’s warehouse and package carriers pick it up at this intermediate warehouse and transport it to the customer (see Figure 5). This option is particularly useful for products with high demand. Inventory will have to increase, but transportation costs will decrease because the transportation mode is more cost effective (e.g. TL). Response time increases because facilities are closer to the customer, which decreases lead time.
Figure 5. Distributor storage with carrier delivery
Distributor storage with last mile delivery: is similar to the above option, but instead of using a
package carrier, the wholesaler or retailer distributes the products themselves to the customer (see Figure 6). The major advantage here is the convenience for the customer.
Figure 6. Distributor storage with last mile delivery
Manufacturer or distributor storage with consumer pick-up where customers place their order
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Figure 7. Manufacturer or distributor storage with consumer pick-up
2.3 Pharmaceutical distribution network
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Figure 8. Traditional simplified pharmaceutical distribution network (Behner & Bünte, 2007)
2.4 Pharmaceutical goods
To understand how medicines are distributed, it is important to understand what types of products exist and how different characteristics of the products require different supply chains. In this paper, two types of products are distinguished: generic medicines and specialty medicines. Generic medicines are copies from medicines of which the patent has expired and are offered at a significantly lower price than specialty medicines. Specialty medicines refer to medicines of high value which compete more on innovation and quality than costs (Kazakov, 2007). The next paragraph will discuss shortly the categorization of medicines in the pharmaceutical supply chain. Three classes of medicinal products can be defined according to the Medicines Act 19681: general sale list (GSL) medicines, pharmacy (P) medicines and prescription only medicines (POMs). The first class, GSL, can be bought at a multitude of location like supermarkets, general stores, petrol stations etc. These products are considered safe and can be bought without the prescription or intervention of a pharmacist. However, GSL medicines are subject to strict rules concerning their use, strength and form. Also the maximum allowance and pack size is controlled for. Some examples of GSL medicines are eye drops, products containing aspirin and products for parenteral administration. Pharmacy medicines, consequently, are allowed to be sold only at pharmacies. Before selling such medicines, the pharmacist must ask some questions in order to ensure that the patient meets the criteria for the use of the medicine. Some of the pharmacy
18 medicines are considered GSL medicines but due to the exceeded maximum dosage limit, these medicines become pharmacy only medicines. In addition, both P as well as GSL medicines can be sold over-the-counter (OTC). To end with, prescription-only medicines must be obtained with the authorisation of a valid prescription form by somebody who is a recognised prescriber and registered at a pharmacy (except for some persons like dispensing doctors).
3. Research methodology
In this chapter the methodology that was used in this research, is presented. The methodology is a case study because it gives an in-depth examination of a contemporary phenomenon whererin the researchers has limited control over events (Yin, 2003). The case used in this study is the pharmaceutical distribution network which “operates as a social network consisting of firms with various relationships” (Choi et al., 2001: 364). Several units of analysis were embedded in the case study: the manufacturing firm, the wholesaler and the pharmacy. These units of analysis are selected because of their relevance and participative role in the pharmaceutical distribution. The manufacturing firm belongs to the ‘distribution network’, the pharmacy belongs to the outbound network and the wholesaler sits inbetween.
3.1 Method and case
An issue that is important here, is whether or not the general forces that were recognized by Rossetti et al., (2011) are also pertinent for the present, pharmaceutical sector. For those trends that are important for the European pharmaceutical industry, it is as a matter of course crucial to determine whether they affect the distribution network design, and in what sense they do. According to Yin (2003) the case study is a suitable methodology when the researcher wants to answer the research question from the perspective of current practice, versus theoretical reasoning. Accordingly, an exploratory case research is preferred as it allows to assess new phenomena in a new light, to search new insights and to ask questions (Robson, 1993; Yin, 2003).
19 was performed at a large Israeli pharmaceutical company which is headquartered in the Netherlands, called Teva Pharmaceutical Industries Ltd. The company is specialized in both generics and specialty medicines and they own more than 73 facilities in the world where they produce all their medicines. Their goal is to provide end consumers with safe and effective products at the right time. This research should therefore support their decision making and guide the strategy of the company regarding their distribution network design in Europe.
3.1.1 Data collection
Several types of information sources were used to collect data. First of all, short interviews were conducted that gave insights into the current distribution network at the case company. Secondly, semi-structured interviews were conducted so that most content of the research would be covered. Interviews were conducted with managers from the distribution network and the outbound network (i.e. the manufacturing firm, wholesaler and pharmacy). By including these perspectives, the distribution from the secondary manufacturing facility until delivery could be analysed, which is referred to as the flow from distribution network to outbound network (Jang et al., 2002).
To enhance both reliability and validity (Karlsson, 2009), an interview protocol was developed (see appendix C). With respect to reliability, the same questions were asked with different wording to see if answers would be consistent. Validity was enhanced by asking similar questions to managers that operate at the same level.
One the one side, the interview protocol was partly based on earlier research by Rossetti et al., (2011) who identified 4 forces (regulatory, channel, compensation and product) that influenced the pharmaceutical distribution network in the United States. Their interview questions were used as a guideline for this paper to identify how and which forces were present in the European pharmaceutical industry. On the other side, distribution network design was constructed using six relevant factors divided in two factors groups which Chopra (2003) described: cost factors (i.e. facility, inventory and transport) and service factors (i.e. response time, product variety and customer experience).
20 The interviews were then recorded with a voice-recorder on either a face-to-face basis or by telephone. Consequently, the interviews were transcribed within 24 hours because this would enhance the reliability of the transcription (Yin, 1994). The interviewees received the transcript to give the opportunity to correct for any misunderstandings.
The different perspectives were expected to give complementary insights into the processes of a distribution network and current developments within the industry. In Table 1 an overview is given of the interviews that were conducted.
Organization Function Topic
Teva Pharmaceuticals Ltd.. Global Procurement Manager Procurement view on developments in PSC Teva Pharmaceuticals Europe B.V. Procurement Manager Europe Procurement view on developments in PSC Teva Pharmaceuticals Europe B.V. European Warehousing Manager Warehousing activities in PSC
Teva Pharmaceuticals B.V. Global Warehousing Manager
Warehousing activities in PSC
Teva Pharmaceuticals Ltd. President and CEO, Generics Europe
Commercial activities in PSC
Mediq & Teva
Pharmaceuticals B.V.
Senior Buyer and Procurement Manager
Pharmacy & Procurement in PSC Phoenix Pharmahandel GmbH & Co KG Manager Pharma Logistics Wholesaler in PSC
Table 1. Overview interviews
During on-site visits in the company warehouse and manufacturing facility in Ulm (Germany) data was gathered on the distribution practices.
3.2 Data analysis and interview protocol
21 managers thought this would impact the distribution of medicines. By exploring these impacts it was possible to relate this to distribution network models. Consequently, in the second phase, data was collected from interviewees and observations. In the third phase, data was analysed according to the three-step approach of Miles & Huberman (1994) which will be discussed in the next paragraph. Lastly the report was prepared.
Miles & Huberman (1994) suggested a three-step approach to analyse data retrieved from interviews. The first step was to group the data into different categories which contain valuable information for the research (Voss, Tsikriktsis, and Frohlich 2002; Miles & Huberman, 1994). Subsequently the data was further categorized for descriptive coding and the last step was to a conclusion (Miles & Huberman, 1994).
Thus, the first step was to reduce the data to sentences or quotes that were relevant for answering the research question. I analyzed the data in relation to trends or developments that were identified by any of the managers and then these findings were categorized in either one of the four main ‘forces’ identified by Rossetti et al., (2011), or the texts were categorized in ‘other forces’ by using descriptive codes (Saldana, 2009). This allowed me to get a first impression on how many findings could be categorized properly, and how many were left to find new categories for. The second step was to create new categories based on the ‘other forces’. Words contained in each quote, sentence or paragraph were interlinked and new categories were created. Consequently, the data was analyzed to filter useful quotes, which count as interpretive codes (Huberman & Miles, 2002). All quotes were then given comment on their possible influence on the six relevant factors of Chopra (2003): facility, inventory and transportation costs, and response time, product variety and customer experience. Some examples of identified trends are given below (Table 2). Results were induced from patterns and underlying arguments.
Categories Example
Regulatory forces [question on postponement] There is also legislation, such as Portugal, there is simply legislation that says you have to have a warehouse in Portugal to sell it there.
22 think there is a very complex change in strategy and mentality needed
Compensation forces In liberal markets the wholesaler has started to charge for service, fee-for-service, the more you want to be supplied the more you have to pay. If you want to make an order by phone, you pay more. Whatever you do, you pay more for more service.
Product forces I think from a general movement it is moving towards specialty or biosimilar. But also generics, they will always play a major role.
Table 2. Forces with example
3.3 Analytical generalization
Analytical generalization is used to generalise findings from a case study with the aim to be applied to other concrete situations, instead of solely contributing to abstract theory building (Yin 2013). According to, Yin (2013), analytical generalization is used to extract a more abstract level of ideas from case study findings – even if ideas pertain to other situations that the case in the original study. I hope to explore which trends are influencing the distribution of medicines in Europe by means of analytical generalization even considering that single-case studies are acknowledged to be limited in generalizability (Karlsson, 2008).
4. Findings
In the following sections the interviews are analysed to provide an answer to the research question. First, however, it was necessary to identify whether the forces discussed in the theory section (i.e. regulatory, channel, compensation and product) also applied for the case company. Subsequently these forces were linked to the DND for either the distribution of generic medicines, or specialty medicines.
4.1 Regulatory forces
Regulatory forces were the second most discussed issue during the interviews and it is mostly considered a risk in the pharmaceutical supply chain. Several regulatory issues were mentioned by the interviewees and eventually the influence of regulatory forces on the distribution network design was twofold.
23 ‘product’, the following example resembles the uncertainties associated with regulatory forces. Last year, legislation with respect to distributing API medicines changed in the sense that monitoring of transport and climate control during transport became mandatory. This meant that the manufacturing company had to invest in new equipment, training for personnel or they had to search for alternative logistic service providers if the current one did not meet the requirements. This uncertainty is a reason for the manufacturing firm to enhance their flexibility and this is in part achieved by outsourcing non-core activities (e.g. warehousing and transport). Enhancement of the flexibility and the resulting outsourcing activities are directly related to facility costs. An increase in outsourcing of transport and warehouse facilities decreases the fixed costs and in turn variable costs increase.
Secondly, as regulation in terms of GDP is becoming more global and European countries are demanding that the import of medicines adhere to their requirements, the design of the distribution network has to be adapted for a global environment. Opinions within the company on internationalizing differ, however, because some managers state that the loss of flexibility, higher lead time and loss of control do not outweigh the benefits of lower production costs. These consequences apply in particular for generic medicines, as the cost pressure would remove much of the relatively low margins. Thus, changing regulations may force this company to move their manufacturing facilities of generic medicines outside Europe. With respect to service factors, this move would decrease response time and increase transportation costs. In turn, it would decrease facility costs.
4.2 Channel forces
Channel forces were the most discussed topic and it referred mainly to the usage and non-usage of the pre-wholesaler and the wholesaler to distribute medicines to the market. The interviewees were asked which and how forces influence the pharmaceutical distribution network in the long term. With regard to channel forces, two trends were discussed: direct sales and mail order. These two topics are solely related to the transport of specialty medicines and they will be discussed next.
24 provide a better care for patients because the company would be more in control. This alternative channel would increase transportation costs because the number of demand points would increase. Inventory and facility costs on the other hand, could be reduced because of the level of aggregation. With respect to service factors, customer experience improves.
The other trend found in the pharmaceutical industry is mail order. Mail order is different from DTP in the sense that customers place their order online, and the pharmacy orders the medicine at the manufacturer to send it to the customer via a mail order distributor. Patients receive their drugs in their mailbox instead of having to pick it up at the pharmacy in the neighbourhood. Besides the time-saving component for consumers, mail orders are normally also provided for a lower price compared to the pharmacy and it enables customers to order ‘anonymously’, which increases the customer experience
Abovementioned alternative trends are directly related to the configuration of the distribution network for high value, specialty and medicines. Instead of the traditional distributor storage with last mile delivery or carrier delivery, it is becoming more common to the manufacturing company to store at their own facility and ship directly to the hospital or patient. The advantage here is that inventory can be centralized and by aggregating demand, the manufacturer can provide a higher level of product availability while maintaining a lower level of inventory.
4.3 Compensation forces
Compensation forces encompass issues like contractual agreements and pricing between firms. Regarding compensation structures, two levels of agreements can be identified: from the manufacturer to wholesaler and from wholesaler to pharmacy. The major issue during interviews was the fee-for-service (FFS) model that is used between the manufacturer and the wholesaler. The FFS model means that manufacturers pay per activity (e.g. receiving goods, storing goods) that the wholesaler performs, irrespective of the value of the goods. This is different from the more traditional percentage model, wherein wholesalers received a percentage of the value of the goods for the services they provided. In Europe, this model is used in the more liberalized markets and during the interviews it became clear the more European countries are becoming liberalized.
25 speculation to cost prices based on operations, which consequently lead to a trade-off in staffing levels and inventory. This has hindered wholesalers to perform like a buffer between demand and supply. The manufacturing company was aware that a certain infrastructure was needed to maintain certain service levels but there was some lack of knowledge regarding the risks that were associated with holding the inventory needed for these service levels.
These findings are particularly important for understanding that wholesalers will become more tolerable towards holding inventory because their revenue stream becomes more sustainable. Thus, inventory costs for storing generic medicines at the wholesaler will increase if more generics are stored. The distribution network design options wherein wholesalers store the inventory before it goes to the customer are likely to become more common for the generic medicine industry.
4.4 Product forces
The commercial manager of the company expects that specialty medicines will become more diversified, deliveries will become more personalized and fewer blockbusters will find their way through the pharmaceutical distribution network. On these findings he mentioned the following:
“I think overall the market will become more fragmented in the sense that the overall trend in the pharma (industry) is that we get less big blockbusters like we had Lipitor [cholesterol-lowering medicine], which was a 12 billion drug. So that means that we will have smaller medicines, so it's going to be more personalised and that means that the turnover per molecule will be smaller, volumes smaller but the price per unit will become higher for all of these drugs”
26 Furthermore, the managers from both the wholesaler and manufacturing company identified a growth in the share of generic medicines. With respect to the increase of ‘cheap’ medicines (i.e. generics), transportation costs can be reduced because of bulk shipments in full truckloads. But for specialty medicines, currently most shipments are LTL because economies of scale are hard to achieve with most medicines. The manufacturing company is therefore looking at opportunities to consolidate shipments with competitors. These differences also confirm the need for different distribution network designs for generic medicines and specialty medicines.
4.5 Summary of findings
The table below clearly summates the relationships between the four forces and the ensuing impact on distribution network design. A short paragraph will be dedicated to wrapping up the findings.
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(+) refers to an increase | (–) refers to an decrease
Force Trend Impact DND aspects Generic (G)
Specialty (S)
Regulatory
Changing legislation
Enhance flexibility leads to outsourcing of
transportation & warehousing
Facility costs:
(–) Fixed facility costs (+) Variable facility costs
GS
Global GDP
Loss flexibility, higher lead times, loss of control, lower costs (–) Response time (–) Facility costs (+) Transportation G Channel DTP/DTH Excluding wholesaler, patient centric healthcare
(+) Transportation costs (–) Inventory costs (+) Customer experience
S
Mail order
Time savings, anonymity for patients (+) Transportation costs (+) Customer experience (–) Inventory costs S Compensation FFS model
Constant revenue streams for wholesaler More visibility manufacturer (+) Inventory GS Product Product diversification
Different truck loadings needed
Centralization of inventory Increase of generics share
(+) Transportation costs (+) Customer experience (–) Inventory costs S Personalised deliveries Different distribution network required (+) Customer experience (+) Transport costs S
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5. Discussion
This study is aimed at offering insights into changing forces in the pharmaceutical industry and their impact on the pharmaceutical DND. To organise the research, the same build-up as the ‘findings’ will be used.
5.1 Regulatory forces
Regulatory forces were mostly referred to topics on globalization. Although Rossetti et al., (2011) used regulatory forces to guide their research, globalization has not been discussed in their paper. Clearly, European managers are more concerned with the different regulations across countries and their impact on the distribution network compared to American managers. Anticipation on possible changes in rules and regulations is crucial and it is therefore valuable to identify certain trends that could influence the distribution network. The issues on globalization will be discussed next.
With respect to globalization and moving plants to China for example, there was no consensus found among the interviewees. It is possible, however, that because of subsidies on R&D investments in the pharmaceutical industry by the Chinese government (Hu et al., 2013), more companies will move their production to China. With this move, the design of the distribution will change in the sense that facility costs, together transportation costs will increase. However, both in the interviews and in literature there is not one clear opinion on globalizing such activities because of disadvantages of greater risk, higher distribution costs, larger inventory buffers that may lead to longer and uncertain lead times (Fagan, 1991). Note that this change concerned only the generic medicines department from the company, thus other pharmaceutical companies that do not produce generic medicines are less likely to experience this trend. It is beyond the scope of the paper to discuss global network design but it is noteworthy to mention that features like exchange rate, tariffs and duties become important for models when firms globalize (Olhager et al., 2015). For a list of factors see the paper of Meixell & Gargeya (2005).
29 like Merck, GSK and Pfizer (PwC, 2011). They argue that the control over these manufacturing facilities is beneficial for their competitive position. For companies that do outsource these activities, the distribution network design should consider external parties in different stages of the distribution network. But more research is needed in this field (Mangiaracina et al., 2015). 5.2 Channel forces
Channel forces were particularly related to mail order and direct shipments. Although the paper by Rossetti et al., (2011) expected that mail order would prevail over direct shipments, this research revealed that the interviewees are focusing more on personalized medicines (see subparagraph 4.1.3) and therefore direct shipments will become more common. Costantino, Gravio & Shaban (2014) mentioned that personalisation not only requires flexibility of the production system but that is also needs specific logistics solutions in order to manage the increased differentiation. Personalisation doesn’t mean that different modular components are assembled to match the customer’s preferences, but rather the amount and mix of active ingredients are matched to a persons’ genes (EMA, 2015). Due to this product specificity, the medicine can be delivered immediately to the patient, or to the health care provider who is allowed to give it to the patient. For the distribution of this type of medicines, a direct shipping model is preferred. Costantino et al., (2014) developed a hierarchal decision making model to choose the best distribution network option for personalised products, considering costs and service level. In line with their findings, the best distribution network alternative which was opted by Chopra (2003) is the manufacturer storage with direct shipping. This option is particularly useful and efficient when the value of the product is high, the demand is unpredictable and the demand is relatively low.
5.3 Compensation forces
30 value anymore. On the other side, manufacturers gain more visibility on how costs are allocated to the activities that they outsource. With the expectation that markets are going to become more liberalized, such FFS models will become more common and depending on the product that the company produces, inventory costs will increase (generics) or decrease (specialty).
5.4 Product forces
Although product forces were a bit underemphasized during the interviews, this is not because they are of lesser importance. Instead, the report of PwC (2011) stressed the importance of product portfolio differentiation and its impact on distribution. Developments like in stem cell research, nanotechnology and tissue re-engineering are among the developments that will likely change the product portfolio. Some of these medicines that are developing will require a finishing touch at the point-of-care or pharmacy. In line with this reasoning, Rossetti et al. (2011) expected that the pharmaceutical supply chain would fragment along different product types. They expected that manufacturers would control the therapeutics, the branded medicines and all cold-chain medicines whereas retailers would control the OTC –and generic medicines. In contrary, in this research, the case company is focussing on the development of both the generics as well as the specialty business and they do not plan to change this strategy.
Another sub-force identified by the managers was the increase in the share of generic medicines, which is confirmed in literature by Vicente & Simoes, (2014). Due to the size of the shipments for generic medicines, trucks can be fully loaded. On the contrary, specialty medicines normally do not achieve this economy of scale. Therefore specialty medicines are currently shipped in less-than-truckloads. Through consolidation the manufacturing company is trying to lower its transport costs. At least this distinction reveals that different transportation is needed for each product, and each product requires a different distribution network design (Jarrah, Johnson, & Neubert, 2009)
5.5 Summary of discussion
31 For generic medicines, the market is very fragmented, there is a high variety of products, the margins are relatively low and most of it is sold in bulk. In addition, service level is highly important. Similar to the research of Costantino et al., (2014), who researched the best distribution option for mass customized products, the best alternatives would be wholesaler storage with customer pick-up or last mile delivery. Inventory is larger than compared to storage at manufacturer, but response times are faster and customer experience is better.
Specialty medicines will become more and more transported directly to the customer. The available choices here are manufacturer storage with direct shipping or manufacturer storage with direct shipping and in-transit merge. The managers agreed that consolidation of shipments with competitor’s medicines is becoming normal, but still the first distribution option is more likely to be used in the short-term.
6. Conclusion
The aim of the research was to see how trends would influence the distribution network design in the pharmaceutical industry. To answer this question, trends identified by Rossetti et al., (2011) were used as a basis to guide the research. In order to identify whether these trends would also apply in Europe, different perspectives from participants within the same pharmaceutical distribution network were gathered in a single case study. The data retrieved from the interviews were analysed and subsequently linked and compared to literature. The next paragraph will first conclude on the findings of the trends, followed by defining how trends influence the distribution network design.
As outlined in the introduction, the expectation was that the same forces from the paper of Rossetti et al., (2011) would apply. The results indicated that the major forces (i.e. compensation, channel, regulatory and product) would indeed all be influential, but to a different extent. Based on the analysis, channel and regulatory forces seem to have the biggest impact on the future distribution network design. Compensation and product forces have been less influential. Some forces only influenced either the distribution network design of generic medicines or specialty, or both types of medicines.
32 Starting with generic medicines, it becomes clear that regulatory forces and in particular global GDP requirements are likely to change the location decisions in DND for manufacturing of generic medicines. This would imply that storage would have to be done at the wholesaler or distributor. Additionally, due to the increased lead time from plant to warehouse, the wholesaler has to maintain a larger inventory buffer to account for uncertainties. Managers should be aware of the risks and costs associated with inventory holding. The FFS model, which was researched as a compensation force, would give better insights into the costs of the wholesaler’s services.
The distribution of specialty medicines received more attention, and more forces were related to them. Channel forces, first of all, merely influenced the distribution network design for specialty medicines. The patient centric health care provision and mail order of medicines are both trends that will foster manufacturing companies to store these medicines themselves, and ship directly from the plants. Though this aggregation would lower inventory costs and improve customer experience, clearly the longer distances will increase costs for distribution. Similarly, product forces were also only linked to the transport of specialty medicines. Product diversification will lead to higher inventory and transport costs because LTL shipments are required. Diversification of products, however, could become a competitive advantage if the supply chain is organized accordingly.
To end with, there were some trends identified that would change the distribution network for both the generic medicines as well as for the specialty medicines. The constantly changing legislation requires a more flexible distribution network, which could be achieved by outsourcing some of the (non-core) logistics activities. Within another force, compensation, only the FFS model was discussed. This model will stabilize costs and revenues for respectively the manufacturer and wholesaler, and it will give better insights into the costs.
6.1 Managerial implications
33 manufacturing companies, but rather against other supply chains. Besides, regulatory forces seem to impact the whole supply chain.
Further, the role and existence of the wholesaler is not likely to change anytime soon. According to Walter et al., (2012), pharmaceutical wholesalers help to secure safe, and continuous products with low transaction costs and no other distribution models is able to do this. Due to their capabilities, and network and market knowledge they are able to supply the medicines with a high service level. Managers from wholesalers, however, should look at alternative revenue streams in order to cover the increasing costs of regulatory issues. Stricter requirements demand higher investments, and thus costs. In order to cover these costs, wholesalers and manufacturers may look into streamlining operations in order to enhance efficiency. Streamlining operations could be achieved by integrating IT-systems for example. The wholesaler did mention already, that vertical integration would be a feasible option for enhancing efficiency.
6.2 Limitations and future research
There are some methodological concerns with the single case study. By conducting a single case study, the findings are little generalizable and it would be useful to replicate case studies to corroborate the paper’s findings. Furthermore, only a limited amount of managers (i.e. seven) could be interviewed due to time constraints. In addition, from this small sample, most of the interviewees belonged to a single company which may create the opportunity for common source bias.
Another limitation that was recognized in the case study, is the fact that some of the interviewees had little experience (i.e. one year) in the pharmaceutical industry. The interviewees understood the basic logistics principles, but were less familiar with the processes specific to the pharmaceutical industry. They were therefore less familiar with trends in the pharmaceutical industry and predictions of the future are therefore not totally well-grounded.
34 preliminary) is elaborated. The second and third step is still there to follow up, which refers to the implementation and evaluation of the DND options. Thus, this paper can be considered a first step to building adequate models in the future for the distribution network design of pharmaceutical companies.
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8. Appendices
Appendix A. Interview protocol
0. Introduction
This protocol describes the field procedures to be followed for each interview 1. Pre-visit preparation
The interviewee should be sent a short summary of what the research stands for and what it aims to do. It should have a general description of the research and a few example questions. If they agree to the description and they consent to the rules, then the interview can be conducted. The interview is preceded by basic research on the background of the person and the company. This research may be annual reports, company history, internet (LinkedIn) and general information in articles and magazines.
2. On-site data collection
At the beginning of the interview, the interviewee should introduce himself by explaining his function and earlier function within or outside the company. This enables the researcher to ask complementary questions but it also justifies whether the right profile has been chosen for the case.
Eventually, the researcher wants to receive information on the following topics: - Trends influencing the distribution network
a. Product and regulatory forces b. Channel forces
40
d. Product forces
3. Trends influencing the distribution network
The following table shows the areas that should be addressed, the questions that the researcher should keep in mind and the unit of measurement.
Context area Job function Questions
Background All - What is your function, and please describe what it entails and what the goals are?
General All - Can you describe the channel complexity in the pharmaceutical distribution network?
- What do you believe will change in the pharmaceutical distribution network in the forthcoming 5 to 10 years? - What do you think will change in reimbursements
requirements?
- Who has the most leverage; manufacturers, wholesalers or providers?
- How are regulatory forces going to impact the distribution network?
- How are product forces going to impact the distribution network?
- How are reimbursement issues going to impact the distribution network?
- How are channel forces going to impact the distribution network?
Product/Regulatory forces
Procurement - How does legislation influence the following issues: manufacturing and distribution facilities, other?
- How does legislation influence in –and outsourcing decisions as well as the use of wholesalers?
Product/Regulatory forces
Commercial party
- How does reimbursement influence the distribution of pharmaceutical?
- How does legislation influence in –and outsourcing decisions as well as the use of wholesalers?
41
forces distribution network design?
- What is the impact of legislation on the distribution network design?
Product/Regulatory forces
Wholesaler - Other persons involved in wholesaler activities, are they GDP compliant? How will this impact distribution?
Channel forces Wholesaler - Are you familiar with RAW – Reduced Wholesaler greement? And if so, how do you expect this to influence your business? - How will retail pharmacies evolve? And E-pharmacy? Compensation forces Wholesaler - How is reimbursement of services likely to change in the next
5 to 10 years?
- Explain how the following issues may impact your business: Pricing pressure from governments? Fee-for-service? Inventory management agreements?
- How do you expect the relationship with the hospitals/pharmacies to change?
- How will compensation structure towards manufacturers change?
- How will compensation structure towards pharmacies change? - And: inventory management agreements, clawbacks,
reimbursements?
Channel forces Procurement - How is the relationship with the wholesaler?
- Is there a trend towards more or less selling to the wholesaler? - Is there a trend towards more or less outsourcing of logistics
activities?
- What capabilities should a manufacturing facility have? Channel forces Warehousing - Is there a trend with respect to outsourcing warehousing
activities?
- Are there trends that influence the current warehousing system?
Channel forces Commercial - Is Teva considering shipping direct to customers and by-pass wholesalers?
- Is there a trend towards more or less selling to the wholesaler? - Do you expect to sell more directly to customer or more via
42
- Are you considering forming an independent channel agreement with a 3PL?
- Can you describe the relationship complexity of the manufacturing firm with the wholesaler/pre-wholesaler? Channel forces Wholesaler - Do you expect more or less buying from the manufacturer?
- Who has the most leverage; manufacturers, wholesalers or providers?
Compensation forces Commercial - What do you see is changing with respect with compensation of wholesalers?
- How are contracts with wholesalers changing?
